Mortgage loans come in many different varieties to suit borrowers with unique housing needs and financial situations. Learn about the most common types of home loans to determine which best suits your needs.
Conventional conforming mortgages follow guidelines, with loan limit maximums that often change annually to reflect increasing home values. They typically require a high credit score and a 20% down payment. To choose the right option for you, talk to Steve Wilcox W/Primary Residential Mortgage, Inc.
Conventional Mortgages
Conventional mortgages are private-sector home loans that do not offer a guarantee from the government. They are typically ideal for borrowers with good credit, stable income, and enough cash reserves to make a reasonable down payment on the residence. Conventional mortgages have higher minimum credit scores and require more documentation than government-backed loans. However, they also generally carry lower interest rates than jumbo loans, FHA loans, and VA loans. Conventional loans can be obtained through almost every type of lender, including banks, credit unions, online lenders, and mortgage brokers.
Conventional loans can be either conforming or non-conforming. Conforming conventional mortgages adhere to the standards, two of the government-sponsored enterprises that buy loans from lenders and pool them as investments. Conforming conventional mortgages must meet certain financing limits for each county in the country, with higher limits for high-cost areas. Non-conforming conventional mortgages are those that do not adhere to these guidelines and may require a larger down payment, higher credit score, or lower debt-to-income ratio than conforming loans.
While conventional mortgages have more stringent eligibility requirements than government-backed programs, they are still available to many borrowers who do not qualify for government-backed options. In addition, conventional mortgages do not come with the program-specific fees associated with government-backed loan types, such as upfront mortgage insurance and monthly payments.
Despite the more restrictive credit requirements and documentation needed for conventional mortgages, borrowers who choose this option can often save money in the long run by choosing a traditional mortgage with low mortgage rates and an adjustable-rate structure. They can avoid the cost of mortgage insurance that is required for borrowers with down payments of less than 20% and can request to have PMI removed once their equity reaches 20 percent. Borrowers should always compare the costs of conventional mortgages with those of government-backed options to determine which is the better fit for them. However, mortgage rates change constantly in response to the economy and borrowers’ ability or willingness to purchase homes, so there is no one-size-fits-all solution for all home buyers.
Fixed-Rate Mortgages
Conventional fixed-rate mortgages are the most popular loan type in the country. They have a 30-year term and have an interest rate that stays the same for the life of the loan. These types of loans help protect borrowers against fluctuating interest rates and allow them to budget for their home purchasing or refinancing plans without having to worry about changing monthly payments.
Borrowers may also choose a shorter-term fixed-rate mortgage, which typically has a lower interest rate. These mortgages have a 15-year term and can save borrowers thousands of dollars in interest costs throughout their loan.
In addition, borrowers can choose between amortizing and non-amortizing mortgages. Amortizing mortgages allow borrowers to pay both principal and interest each month, which helps them build equity in their homes. Non-amortizing mortgages, on the other hand, require that all of a borrower’s monthly payments go toward interest charges, which can lead to the repayment of their entire debt before they have built up much equity in their homes.
Regardless of the terms chosen, all conventional mortgages must meet certain standards to be approved for financing. The most important qualification is a strong credit score, which can make or break a potential borrower’s chances of qualifying for a mortgage and receiving the best interest rates available. To improve their odds, borrowers should take steps to fix any issues that may be negatively impacting their credit scores before applying for a mortgage.
Another mortgage loan option that is popular for homeowners and homebuyers is an adjustable-rate mortgage or ARM. These mortgages come with a low introductory rate for an initial period, which can range from three to 10 years, depending on the lender. Afterward, borrowers’ interest rates can change periodically. ARMs can be appealing to borrowers who want to buy or refinance their homes at a lower interest rate but plan on moving in the future.
As interest rates rise, the demand for ARMs has also increased. With many lenders now offering a wide range of ARMs with different initial terms, it’s important for potential borrowers to carefully consider their options before choosing the right type of mortgage for them.
Adjustable-Rate Mortgages (ARMs)
An ARM is a home loan that allows your interest rate to adjust based on a variable index. This is what makes them popular among homebuyers who plan to stay in their homes for only a few years, as they can take advantage of lower initial rates than they would receive on a fixed-rate mortgage.
In addition, many ARMs come with caps that limit how much your interest rate and payment can rise from one adjustment period to the next, which helps to mitigate the risk of unpredictable market trends. These caps are typically set on a monthly, periodic, or lifetime basis.
When comparing ARMs, it is important to look at the terms of each product to determine which is the best fit for your situation. The most common ARM products feature an initial period and an adjustment frequency that is determined when you apply for the loan. For example, a 5/1 ARM offers an initial period of five years before the loan’s interest rate is adjusted, and then it will adjust once per year thereafter.
The interest rate that affects your monthly payments on an ARM is based on the index it is tied to and the margin added to that index. The index is typically a widely used benchmark like the SOFR (Selective Offered Frequency Ratio), which is the average of the yields on 10-year Treasury bills. The margin is a fixed percentage that is negotiated at the time of application and may be influenced by your credit score and other factors.
Generally, the most creditworthy borrowers will pay close to the standard margin, while loans made to higher-risk borrowers may be marked up further. Some ARMs also have caps that are established at the time of origination and do not change over the life of the loan.
For most borrowers, an ARM is an excellent option for taking advantage of attractive introductory rates and helping to finance the home they want without stretching their budget too thin in the beginning. However, these loan types aren’t for everyone, as they can become costly if market conditions lead to big interest rate increases that you cannot afford.
FHA Loans
If you’re in the market to purchase a home, you have many mortgage options to consider. Carefully weighing the pros and cons of each is an important first step to finding the best fit for your unique financial situation.
FHA loans have more lenient credit, down payment, and debt-to-income requirements than conventional loans. However, lenders still must verify your income through pay stubs, W-2s, and federal tax returns.
The FHA also requires that your DTI, or debt-to-income ratio, be at or below 43 percent. This is much lower than the maximum DTI of most other loan types, allowing you to qualify with a higher income and lower credit score. However, it is important to note that if your DTI is too high, you could have trouble qualifying for the loan or may be charged a higher interest rate.
While you can get an FHA mortgage with a qualifying credit score as low as 500, it’s more common to need 620 or higher to qualify. Additionally, you’ll need a minimum down payment of 3.5%.
Compared to conventional loan programs, you’ll typically pay a lower mortgage insurance premium with an FHA loan. This is due to the government’s guarantee of the loan, which protects the lender if you default on your payments.
Another advantage of an FHA loan is that it’s easier to refinance, if necessary. You can do this in a few different ways, including through the FHA program, which eliminates some of the costs and steps that are required for other refinances.
While FHA loans have many benefits, it’s important to know your options and understand what you’ll be responsible for upfront and over the life of the loan. As mortgage rates continue to remain low, this is an excellent time to shop around for the best rates and find a lender that’s a good fit for you.
Contact us to learn more about the mortgage process and the loan types that may be right for you. Our experienced professionals will work with you to find the right solution that fits your lifestyle and budget.
