With so many alternatives on the market, choosing the best mortgage loan can be stressful. Before selecting a mortgage loan or lender, find out about the different mortgage types, terms, and types of interest rates.
Below, we’ll guide you through the process of selecting a mortgage to purchase, build, or renovate your home.
Types of Mortgage Loans
A mortgage is a type of loan used to purchase, refinance, or remodel a home. Banks, credit unions, and other financial institutions offer conventional, nonconforming, and government-backed mortgage loans.
A good way to compare between different home loans is with our home affordability calculator, where you can input different loan types and terms to see a ballpark payment.
Conventional Mortgage Loans
There are different types of conventional loans, and application requirements for each depend on the loan and lender type.
Originated and serviced by several different types of financial institutions, including banks and credit unions, conventional loans tend to have stricter eligibility requirements than government-backed loans and usually require the borrower to have both a higher credit score and a debt-to-income ratio of 36%, although some lenders will accept DTI’s as high as 50%. They commonly have 15-, 20- or 30-year terms.
Conventional loans are available for purchase, renovations, or home refinance. If you’re still deciding on a type of mortgage loan or lender, check our selection for the best mortgage lenders.
Conventional mortgages aren’t insured by the federal government, and are classified as conforming or nonconforming.
- Conforming loans follow funding requirements established by Freddie Mac and Fannie Mae (two federally backed home mortgage companies created by the U.S. Congress) or exceed the loan limits set by the Federal Housing Finance Agency (FHFA).
- Nonconforming loans don’t follow those underwriting guidelines and/or exceed the FHFA loan limits.
Conforming Mortgage Loans
As we mentioned above, a conforming mortgage is a conventional loan that meets the funding criteria set by Fannie Mae and Freddie Mac, and the FHFA loan limits. The latter means that the loans cannot go over a certain amount, which for single-family homes in 2022 is a base of $647,200 (and $970,800 in high-cost areas, as well as Alaska, Hawaii, Guam, and the U.S. Virgin Islands). Conforming loan terms generally range between 10 and 30 years.
A conforming mortgage is suitable for those who:
- Want to avoid high-interest payments
- Can make larger down payments
- Are purchasing a home not exceeding the limits established by Fannie Mae and Freddie Mac
Nonconforming Mortgage Loans
Nonconforming mortgages are loans that don’t meet Fannie Mae or Freddie Mac’s standards for purchase, whether it’s because they don’t fulfill FHFA requirements, or because the loan amount is too large. These include the three main government-backed mortgages — Federal Housing Administration (FHA), United States Department of Agriculture (USDA) and U.S. Department of Veterans Affairs (VA) — as well as jumbo loans.
FHA, USDA, and VA mortgage loans are insured by the government in case of a default, but are processed and managed by authorized private mortgage lenders. These types of mortgages allow potential homeowners to buy a home with a down payment of 10% or less, lower minimum credit requirements, higher loan limits, and a higher debt-to-income ratio.
Nonconforming loans are a good option for potential borrowers who:
- Don’t have a 20% down payment
- Have a low credit score and a high debt-to-income ratio
- Have a unique financial situation, such as a bankruptcy, and are looking for a tailored option
Government-backed loans are also available for refinancing other nonconforming loans. If you’re looking to refinance your home, check our selection for the best mortgage refinance companies.
Jumbo loans are not insured by the government, and have different requirements than government-backed loans. They are considered nonconforming because they exceed the FHFA loan limits.
Jumbo loans can be used to purchase a primary residence, vacation home, and other investment properties as well as refinance an existing loan. Lenders offer both fixed or adjustable rates and a variety of terms.
To apply for a jumbo mortgage, lenders require proof of steady income, information about assets, and any cash influxes. These must prove the borrower can afford their monthly mortgage payment over the long run. Since jumbo loans are riskier for lenders than conforming loans, in many cases, borrowers will be required to put down a higher down payment and pay higher closing costs.
Jumbo loans are a good option for potential borrowers:
- With a high credit score and a low debt-to-income ratio
- Interested in properties exceeding the FHFA limit
Government-insured Mortgage Loans
Government-insured mortgages are loans insured by either the Federal Housing Administration, the U.S. Department of Agriculture, or the Department of Veterans Affairs and provide potential homeowners lower credit score requirements, down payments, and closing costs. FHA, USDA, and VA loans are loan options considered to be government subsidized.
Government-subsidized loans like FHA mortgages may require a minimum down payment of just 3.5% (provided you meet certain guidelines) and offer 15- and 30-year terms with fixed or adjustable interest rates. Others like VA and USDA loans, don’t require a down payment.
FHA loans allow potential homebuyers to purchase their home, finance home energy improvements or fund renovations. These loans are generally available for properties with 1 to 4 units that are a principal residence and are owner-occupied. This means they’re not usually available for rental or investment properties.
It’s important to clarify that the FHA isn’t actually lending you the money — an FHA-approved financial institution is — but the government agency does guarantee the loan in case of default.
FHA loans are designed for first-time homebuyers or individuals who haven’t owned a home in at least three years. However, FHA loans can also be approved for those who are not first-time or recent homeowners, provided they’re purchasing a residence in an area targeted for revitalization. This loan typically requires a low down payment of 3.5% and is offered in a variety of term lengths.
Before applying for an FHA loan, you’ll need an appraisal from an FHA-approved appraiser to make sure the property follows the guidelines and requirements established by the US Department of Housing and Urban Development (HUD). Other requirements include:
- A minimum of two years of work history, or two years of gainful self-employment history
- A minimum credit score of 580 or higher to qualify for a 3.5% down payment
- A minimum of three years from any bankruptcy event, unless it was due to an unforeseen circumstance
- No delinquencies on federal student loans or income taxes
Bear in mind that borrowers in an FHA loan program must also pay a mortgage insurance premium (MIP) for eleven years or the life of the loan, depending on your loan to value ratio (LTV).
Potential borrowers can obtain an FHA loan pre-approval after a lender reviews their income, down payment amount, credit score and history.
FHA loans are a good option for:
- First-time homebuyers or potential homeowners with a low credit score
- Potential homeowners without savings for a sizeable down payment
- Homeowners interested in major renovations
A VA loan is partially guaranteed by the United States Department of Veterans Affairs (VA), but provided by financial institutions such as banks and credit unions. To apply for a VA loan, potential borrowers must be military service members, including National Guard members with at least 90 days of active service, the spouse of a military service member with a full VA entitlement, or the spouse of a military member who died in the line of duty or as a result of a duty-related injury.
VA entitlement is the amount the Department of Veterans Affairs will guarantee on a borrower’s loan.
Some of the benefits of VA loans are:
- No down payment required, if the sales price isn’t higher than the home’s appraised value
- No Private Mortgage Insurance (PMI) required
- Lower interest rates
- 15- and 30-year terms
- Being able to borrow up to Freddie Mac and Fannie Mae’s conforming loan limits with no down payment, in most areas
- Less closing costs
- No prepayment penalty if you pay off your loan early
VA loans require borrowers to pay a funding fee of 2.3% of the amount borrowed. For those home buying military members who have taken out a VA loan before, the required funding fee is 3.6% unless the borrower puts down at least a 5% down payment.
Access to VA loan programs is a lifetime benefit, and military service members can have access to this type of loan over and over again. There are several different types of VA mortgages:
VA loans are a good option for:
- Military members and their spouses
- Military members interested in purchasing a home without a down payment
- Military members interested in lowering their mortgage interest rate and monthly mortgage payment
If you’re interested in this type of loan, check our selection for the best VA loan lenders.
USDA loans are available for low- and moderate-income rural households or potential homeowners in rural areas. This mortgage is guaranteed by the United States Department of Agriculture. USDA loans are available for those interested in building, purchasing, renovating, or renewing an existing USDA loan.
To qualify, potential borrowers must meet the following criteria:
- The home must be used as a primary residence
- Total income must not exceed 115% of the U.S median family income
- Be a U.S citizen, or a Naturalized U.S. citizen
USDA loans offer 100% financing to build a new home, purchase, or rehabilitate a residence. This type of loan can also be used to cover site preparation costs or the acquisition of appliances, carpeting, heating, or cooling systems.
One of the benefits of USDA loans is that they don’t establish a minimum credit score, although many lenders will usually require a minimum score of 640. However, potential borrowers have to show documentation proving they can manage and pay their debts. Authorized lenders require borrowers to pay closing costs, which include lender fees, title fees, property taxes, homeowners mortgage insurance premiums, and an upfront guarantee fee.
Some of the downsides of USDA loans are that homebuyers usually pay around 2%-5% of the purchase price in closing costs and are only offered in a 30-year loan term. The property to be financed cannot be a working farm, it must be accessible from a paved or conditioned road, and its water and electrical system must be fully functional.
USDA loans are a good option for:
- Potential homeowners and homeowners in rural areas
- Households with less than the USDA household income limits
- People who are okay with a 30-year mortgage term
Home construction loans
Home construction loans are shorter term loans designated to cover the costs of home construction or renovations. The term for these loans is usually 12 months or less, and the borrower must either pay the loan in full at the end of the term or secure a mortgage.
The loan is disbursed as construction phases reach completion. Before the end of the term, the borrower is responsible for paying for the interest accumulated on the money withdrawn.
Because of their short-term lengths, home construction loans are considered a high risk for lenders and therefore have higher interest rates. To apply, lenders require evidence of a detailed construction plan with a timeline and budget.
A home construction loan can be converted to a permanent loan, though this may be expensive because you’ll end up covering closing costs for both. Borrowers should plan accordingly and decide if they want a construction-to-permanent loan or just a construction loan.
Home construction loans are a good option for borrowers who:
- Don’t have enough money to cover home construction costs
- Can only afford interest rate payments for a short period of time
- Will be able to pay the loan in full after 12 months
Balloon Mortgage Loans
Balloon loans are a type of mortgage that allows the borrower to only make interest payments for a short fixed term of five to ten years. Afterward, the borrower must pay the remainder loan balance in one single payment.
This loan is a good option for borrowers planning on:
- Selling their home before the term ends
- Taking on a mortgage loan at the end of the term
Types of Mortgage Loan Terms
A 30-year mortgage is one of the most common term lengths, since buying a home is potentially the most expensive home purchase a typical person will ever make. As the loan is spread out over a longer time period, borrowers can obtain a lower monthly payment.
This term length is a good option for potential homeowners with good credit looking for affordable monthly payments. Having good to excellent credit can help obtain a low interest rate and access to larger loan amounts.
If the borrower’s financial situation improves and they’re able to pay off the loan before the end of the term, many lenders have eliminated prepayment penalties allowing homeowners to pay the loan in full before the 30-year term ends at no extra cost.
If paying a mortgage for 30 years seems like a long time but the monthly payments for a 15- or 10-year mortgage is too high, a 20-year mortgage is a good (though somewhat rare) option. If the borrower is able to lock in a low interest rate, a 20-year mortgage can be less expensive than a 30-year mortgage.
15-year term lengths tend to have higher monthly payments, but they accrue less interest than a 20- or 30-year mortgage, resulting in savings for the borrower.
This mortgage term is a good option for people whose financial plans might include robust retirement savings or simply being debt-free by a certain age.
10-year mortgage terms are even less common than 20-year terms, perhaps because even though they allow borrowers to save the most on interest rates, monthly payments are much higher.
At the beginning of the repayment period, most of the monthly payment will go towards the interest rather than the principal.
This term is a good option when interest rates are low, if you’re looking to build equity quickly. However, since it does come with a high monthly payment, borrowers should be prepared in case of unemployment or sudden inflation, increasing the cost of living.
Types of Mortgage Loan Interest Rates
There are two types of interest rates: fixed and adjustable. Before determining what type of mortgage interest rate is more convenient, take a look into your financial situation and goals.
Fixed-rate loans are mortgages with a stable payment and interest rate that remain fixed over the life of the loan. The only way of lowering the interest rate or term length on a fixed-rate loan is to refinance.
There are three main elements you should consider when looking for a fixed-rate mortgage:
- Interest rate
- Loan amount
Fixed-rate mortgages are predictable, making it easy for potential borrowers to budget for their monthly payments. They’re best for people who are planning to stay in their home for a long period of time, and aren’t looking to purchase a starter house. One downside to a fixed-interest rate mortgage is that if interest rates drop, the borrower will still be tied to the rate they locked in at the time of closing the mortgage loan.
Adjustable-rate mortgages (ARMs) are loans where the interest rates applied on the outstanding balance can change throughout the life of the loan.
Also called variable rate or floating rate mortgages, you’ll often see ARMs written out as two numbers with a backslash in between. The first number corresponds to an initial period in which the loan will have a fixed interest rate. The second number usually refers to how often the rate will adjust after the initial period, based on a benchmark interest rate.
While adjustable periods can take place at different times, ARMs have a cap on how much the interest rate and monthly payment can increase.
ARMs are convenient for people who are either not planning on staying in their home after the initial fixed rate period, planning on refinancing before the fixed-rate period ends or are home buying when interest rates are high (and they hope to see rates go down after the initial period). Conversely, a borrower might see interest rates go up once they start changing regularly.
ARMs can be risky because the monthly payments can increase when rates increase and can be higher than what you can afford. If you’re not sure how high a monthly payment you can afford, check the most current mortgage rates and take a look at our mortgage calculator.
Bottomline about Types of Home Loans
Since there is such a wide variety of mortgage types and loans, choosing the best option will depend on the property, its location and value, and the borrower’s credit history and score.
There are government-backed options for those with low credit scores, a high debt-to-income ratio, and for first-time homebuyers. Potential borrowers should plan and determine what term, interest rates and lender offers the best option to afford their home and stick to their financial goals.
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