Understanding the Different Types of Mortgage Loans
Financing a new home can be a stressful situation, especially if it’s your first one. A new home is an incredibly big purchase, and agreeing to a mortgage that could last for decades is an equally sizeable decision. Before you settle on an option, it’s important to understand all of the various loan products available.
Different mortgages have different requirements, advantages and disadvantages that must be weighed by borrowers before they take the plunge. Here’s a guide to understanding the different types of home mortgage loans, which will help you select the one that fits your unique financial situation.
Fixed versus adjustable rate
All mortgage options are offered as either fixed- or adjustable-rate loans, which will determine the mortgage rate’s volatility (or lack thereof).
Fixed-rate mortgages provide borrowers with a set interest rate and monthly principal that both remain the same over the entire life of the loan, as opposed to rising and falling along with market rates. The cost of fixed-rate mortgage payments can fluctuate as a borrower’s property taxes or homeowners insurance rates change, but the rate and payment amount remain stable.
Most fixed-rate mortgages feature 15-year or 30-year loan terms, though there are other lengths available. The longer the loan term, the lower the monthly payment, as the amount is spread out over a greater period of time. Longer term loans typically carry higher rates. Generally, fixed-rate mortgages are recommended to borrowers planning to stay in their home for seven years or more, and who want a reliably steady mortgage they can pay off over a significant period of time.
An adjustable-rate mortgage (ARM) , by contrast, will traditionally feature a regularly occurring interest rate change, often after every six months or year.
There are also hybrid ARMs, which combine fixed- and adjustable-rate mortgages by offering a lower initial interest rate at the start of the loan term, and then later adjusting periodically to match prevailing interest rates. For example, the common 5/1 ARM has a lower initial rate that remains fixed for the first five years of the loan, and then adjusts to a new rate every year for each remaining year.
Because of the lower initial savings, ARMs are generally recommended to borrowers who can afford to pay off their loan relatively quickly, or who expect to move and resell their property before the rate increases kick in.
Conventional vs. government-backed loans
In addition to the choice of a fixed- or adjustable-rate mortgage, borrowers are also presented with a choice between conventional loans and home loans insured by the government.
A conventional home loan is a unique mortgage product issued by a private lender and not insured by the federal government. Many private lenders also issue government-backed loans, but these are federally insured and only available in three distinct types.
Mortgages insured by the Federal Housing Administration, known as FHA loans, are available to all types of borrowers, though especially popular with first-time homebuyers. Because the government insures the lender against losses that might result from a default, borrowers face lower barriers to entry, including a down payment as low as 3.5 percent of the purchase price. However, FHA loans do require you to pay for mortgage insurance, which will drive up the amount of your monthly payments.
VA loans are provided through the U.S. Department of Veterans Affairs and available to qualified military service members and their families. Similar to FHA loans, yet even more generous, VA loans allow borrowers to receive 100 percent financing for the purchase of a home, meaning zero down payment. However, only a select group of people qualify, including veterans, active duty service members, National Guard members and reservists who meet the basic service requirements, as well as spouses of military members who died while serving.
Finally, the United States Department of Agriculture (USDA) has a loan program for rural borrowers with low to moderate incomes. USDA loans are specifically available to “rural residents who have a steady, low or modest income, and yet are unable to obtain adequate housing through conventional financing.”
Jumbo vs. conforming loan
The last distinction to be made is based on the size of the loan, and whether it conforms to the underwriting guidelines of Fannie Mae or Freddie Mac, or whether its price exceeds them.
Annually, Fannie Mae and Freddie Mac set the limit on the maximum value assigned to a conforming loan. Any home purchase price that exceeds that sum would require borrowers to obtain a jumbo loan. Because of the increased price and risk, jumbo loans do tend to carry larger down payments and stricter requirements than their conforming loan counterparts. However, if you live in an especially pricey housing market, you may have no choice but to apply for a jumbo loan.
It’s important to understand that many of these loan types work in conjunction with one another. For example, conventional loans, FHA loans and jumbo loans are all available as fixed-rate mortgages. Borrowers need to figure out which loans they qualify for, which of those offer them the best deal and whether they should structure it as a fixed-rate or adjustable rate mortgage.
To learn more about your various loan type options, talk to the experts at Trustmark about which mortgage is right for you. Trustmark provides conventional fixed- and adjustable-rate mortgages, jumbo loans and all of the government-backed mortgages.