Choosing the best mortgage loan for you from these nine types of loans for homes is critical for saving money. Plus, your monthly payments will be as low as possible. That is in addition to actually getting a home mortgage.
1. Conventional Loans That Bankers Hate and Love
This type of loan is normally used for borrowers that have a good credit score.
The federal government does not back conventional loans, and they come in two flavors: non-conforming and conforming.
- Non-conforming loans – This type of loan does not meet Federal Housing Finance Agency (FHFA) standards. They are usually offered to borrowers that have a subpar credit score, or for larger homes. Non-conforming loans are often designed for individuals who have experienced a major financial catastrophe like bankruptcy.
- Conforming loans – Conforming loans “conform” to a set of standards implemented by the FHFA. These standards include several factors about a borrower’s debt and credit, but one of the main criteria is the loan size. In 2022, the conforming loan limit is $647,200 in most areas and $970,800 for areas that are more expensive.
Conventional Loan Advantages
- Overall borrowing costs are generally lower than other types of loans for homes, although the interest rate is slightly higher
- Can be used for primary homes, second homes, or investment properties
- Pay as little as 3% down on loans backed by Freddie Mac or Fannie Mae
- Can ask lenders to cancel private mortgage insurance (PMI) once 20% equity has been reached, or refinanced to remove it
- The seller can fund part of the closing costs
Conventional Loan Disadvantages
- A higher down payment is required than with most government loans
- Minimum FICO score of 620 or higher needed (also for refinancing)
- Likely have to pay PMI if the down payment is less than 20% of the selling price
- DTI (debt-to-income) ratio of no more than 43% required (50% in some cases)
- Documentation needed to verify assets, income, employment, and down payment
Who Should Use Conventional Loans?
For individuals with a strong credit score and who can afford to make a substantial down payment, a conventional mortgage is probably one of the best types of loans for homes available. A fixed-rate 30-year conventional mortgage is very popular with homebuyers.
2. Government-Insured Loans for Everyone
This type of loan is normally best for borrowers with little cash for a down payment and who have a lower credit score.
Although the American government isn’t a mortgage lender, it does try to help more Americans to become homeowners. There are 3 government agencies that back mortgages: the U.S. Department of Veterans Affairs (VA loan), the U.S. Department of Agriculture (USDA loan), and the Federal Housing Administration (FHA loan).
VA Loan (Veterans Administration Loan)
A VA loan provides low-interest, flexible mortgages for U.S. military members (both on active duty and veterans) and their families. A VA loan does not need mortgage insurance or a down payment, and closing costs are normally capped and may even be paid by the seller. A funding fee is charged on a VA loan as a percentage of the loan amount to assist in offsetting the program’s cost to taxpayers. This fee, together with other closing costs, can be paid upfront at closing or is often rolled into a VA loan. Many lenders charge the lowest possible rates on a VA loan, and some also accept lower credit scores.
USDA Loan (United States Department of Agriculture Loan)
A USDA loan helps low- to moderate-income borrowers buy their own homes in rural areas. Homes must be purchased in a USDA-eligible area and certain income limits need to be met to qualify. Some USDA loans for eligible borrowers with a lower income don’t require a down payment. However, there are extra fees, including an upfront fee of 1% of the loan amount (which can normally be financed with the loan) and a yearly fee.
FHA Loan (Federal Housing Administration Loan)
Backed by the FHA, these types of loans for homes help in making homeownership possible for borrowers whose credit record is not pristine or don’t have a big enough amount saved up for a down payment. Borrowers require a minimum 580 FICO score to get a 3.5% down payment with the FHA maximum of 96.5% financing. However, a score of 500 is acceptable if you can put at least 10% down.
FHA loans need two mortgage insurance premiums: Although one is paid upfront, the other is paid yearly for the loan’s lifetime if your down payment is less than 10%. This can increase the overall mortgage costs. Home sellers are allowed to contribute to closing costs with an FHA loan.
Government-Insured Loan Advantages
- More relaxed credit requirements
- Help individuals who don’t qualify for conventional loans to finance a home
- Available for first-time and repeat buyers
- Large down payment not required
- No mortgage insurance requirements and no down payment needed for VA loans
Government-Insured Loan Disadvantages
- FHA loan limits are lower than conventional mortgages in many areas, limiting the potential home selection
- Mandatory mortgage insurance premiums payable on FHA loans can’t be canceled unless it is refinanced into a conventional loan
- Overall borrowing costs may be higher
- The borrower must reside on the property although a multi-unit building may be financed and other units rented out
- More documentation is required to prove eligibility, depending on the type of loan
Who Should Use Government-Insured Loans?
For individuals not able to qualify for a conventional loan due to limited savings for a down payment or a lower credit score, USDA-backed and FHA-backed loans are a good option. VA-backed loans are often a very good option for military service members, veterans, and spouses that are eligible, often better than conventional loans.
3. Jumbo Loan
This type of loan is normally best for individuals with excellent credit scores wanting to buy an expensive home
Jumbo mortgages are named aptly as these are loans that fall outside FHFA limits. Jumbo loans are most common in high-cost areas like San Francisco, Los Angeles, the state of Hawaii, and New York City. These bigger loan amounts creates more risk for the lender. So, this type of loan normally needs a larger amount of documentation to qualify.
Jumbo Loan Advantages
- Interest rates are generally competitive when compared with other conventional loans
- More money can be borrowed to buy more expensive homes
Jumbo Loan Disadvantages
- A 700 FICO score or higher is typically needed
- Down payment of between 10% and 20% required
- Must prove you have significant savings accounts or assets in cash
- DTI ratio may not be higher than 45%
Who Should Use Jumbo Loans?
A jumbo loan is probably your best option if you want to finance for an amount bigger than the current conforming loan limits.
4. Adjustable-Rate Mortgage (ARM)
This type of loan is normally best for individuals who don’t want to stay in a home for long and are happy with the risk of bigger payments later on.
Adjustable-rate mortgages (ARMs) don’t have the stability that fixed-rate loans do, because their interest rates fluctuate and can go up or down depending on market conditions. Many ARM products use a fixed interest rate for the initial period before it changes to a variable interest loan for the rest of the term. You might for example get a 5-year/6-month ARM, which means that the rate will stay the same for the first 5 years and will then be adjusted every 6 months thereafter.
If you are thinking of getting an ARM, it’s crucial that you first read the fine print to determine by how much the rate can increase and how much you may end up paying after the initial period has expired.
- A substantial amount can be saved on interest payments
- Relatively low fixed rate in the initial period of homeownership. This is however not guaranteed. Lately, 30-year fixed rates have kept pace with 5/1 ARMs
- If home values drop in a few years, it may be more difficult to sell or refinance before the loan resets
- Monthly mortgage payments may become unaffordable, leading to a loan default
Who Should Use ARMs?
If you are not planning on staying in a home for more than a few years, ARMs may help you decrease interest payments. However, it is important that you are comfortable with the risk that your payments may increase if you stay in the home longer than expected.
5. Fixed-Rate Mortgages
This type of loan is normally best for individuals who want the surety of having to pay the same amount throughout the loan.
Fixed-rate mortgages’ interest rate stays the same over the entire lifetime of the loan. So, the monthly mortgage payment also stays the same. Fixed loans are normally available in terms of 30 years. However, 15-year home loans are very popular for borrowers who are refinancing. Also, some lenders permit borrowers to select any term between 8 and 30 years.
Fixed-Rate Mortgage Advantages
- Budgeting becomes more precise
- Monthly interest and principal payments remain the same throughout the loan’s lifetime
Fixed-Rate Mortgage Disadvantages
- Interest rates are normally higher than adjustable-rate mortgages’ rates
- Typically have to pay more interest in total with longer-term loans
Who Should Use Fixed-Rate Mortgages?
If you plan to stay in a home for at least 5 to 7 years and want to prevent the possibility that your monthly payments will change, a fixed-rate mortgage is the right option for you.
Consider These Other Types of Loans for Homes
Apart from the types of loans for homes mentioned above, there are several other types you may discover when looking around for a loan:
6. Interest-Only Mortgages
With interest-only mortgages, the borrower only pays the loan’s interest for a set period. Once that time has expired, normally between 5 and 7 years, the monthly payment increases as you start paying back on the principal. This type of loan doesn’t allow for building equity quickly as only the interest is paid initially. These loans are best for individuals who know they can refinance or sell, or for those who expect they’ll be able to afford the higher monthly payment later on.
7. Construction Loans
When building a home, a construction loan is often a good option. You can select whether you want a construction loan for the project and then a separate mortgage loan to pay it off or combine the two options (called a construction-to-permanent loan). A higher down payment is typically needed for a construction loan, and you need to prove that you can afford the expenses.
8. Balloon Mortgages
Other types of loans for homes include balloon mortgages, which need a big payment to be made at the end of the loan’s term. You’ll typically make payments based on a term of 30 years, but only for a short period e.g. seven years. At the end of the period, you have to make a huge payment on the remaining balance. However, this can become a huge problem if you’re not able to pay it off. So, plan to refinance before that day comes.
9. Piggyback Loans
A piggyback loan is also known as an 80/10/10 loan. This type of loan involves two loans: one for 80% of the home’s price and another loan for 10%. You also have to make a down payment of 10%. This type of loan was designed to assist a borrower in avoiding paying for mortgage insurance. Although it might sound appealing to eliminate PMI payments, it should be noted that piggyback loans have two loans accruing interest and need two sets of closing costs. You’ll need to look at the numbers carefully to determine if you’ll really save enough to make this unconventional arrangement worthwhile.
Need Help Getting One Of These 9 Types of Loans for Homes?
To determine the best type of mortgage for your needs it is best to apply for a free prequalification. That way the lender can suggest the type of loans you would most easily qualify for. To do that, the lender needs to check your credit history, which will not harm your credit score. Plus, they will need to ask about your income and current debts. Also, be sure to let them know how much cash you have available for down payments and closing costs. That will also help them to determine which of these 9 types of loans for homes is best for you.