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Types of mortgage loans

How to choose the right home loan for you

Profile picture of Michele Lerner
by Michele Lerner Mortgage & Real Estate Contributing Editor
Houses in a neighborhood

A mortgage is a legal agreement between you and a lender in which immediate funds are provided for a property in exchange for repayment of the loan with interest over time.

When you get a home loan, your property is used as collateral, meaning the mortgage lender has the right to foreclose on your house to recoup its funds if you fail to repay the loan according to specific, agreed-upon terms.

What are the different types of mortgage loans?

Mortgage types for homebuyers are categorized as conventional or government-backed and can be either conforming or nonconforming. Depending on the type of loan, you might have to choose between fixed or adjustable interest rates.

  • Conventional loans: Conventional loans are mortgages issued by private lenders. They are not guaranteed by the federal government. A conventional loan can be conforming, with limits set by the government and Fannie Mae and Freddie Mac, which back conforming loans — or nonconforming, with less standardization for eligibility, pricing and features. A jumbo loan with a high dollar amount is an example of a nonconforming loan.
  • Government loans: These loans are insured by the government and often have more lenient eligibility requirements than conventional loans. Examples of government loans include FHA, VA and USDA home loans.
  • Fixed-rate mortgages: A fixed-rate mortgage includes a set interest rate for the entire duration of the loan.
  • Adjustable-rate mortgages: An adjustable-rate mortgage has a rate that’s initially fixed for a set period, then it adjusts. For example, a  5/1 adjustable-rate mortgage has a fixed interest rate for the first five years of the loan duration, then there's an annual adjustment.

Other types of mortgage loans

A home refinance loan, in which the borrower takes out a new mortgage to replace an old one, is a way to lower your interest rate and reduce monthly mortgage payments or to take advantage of equity and get cash (cash-out refinance).

A second mortgage is an additional mortgage that allows you to borrow money against your home’s equity. Home equity loans and home equity lines of credit are examples of second mortgages. Homeowners might take out a second mortgage to consolidate debt or to make home improvements.

Conventional loans

Banks and other lenders offer conventional mortgage loans, which are not backed by the government. Conventional mortgage loans are classified as either conforming or nonconforming, depending on whether they conform to federal mortgage loan limits and terms set by the Federal Housing Finance Agency (FHFA) and Fannie Mae and Freddie Mac, government-sponsored enterprises that guarantee most mortgages in the U.S.

Conventional 97 loans are offered by Fannie Mae to first-time homebuyers for an amount up to 97% of the property value. To qualify for a conventional 97 mortgage, the property must be a single-unit home that will be used primarily as a residence. Conventional 97 loans have fixed rates and carry a term of up to 30 years.
HomeReady is one of two loan programs offered by Fannie Mae to low- and moderate-income buyers who need to buy or refinance a home. It offers a lower down payment and borrower contribution, more affordable mortgage premiums and a flexible approval process. It allows family members or friends to co-sign on your loan and considers income from other household members for approval.

To qualify, you must meet an income limit requirement, typically equal to or less than the area median income. You need a minimum credit score of 620. Homeownership education is required.

Home Possible and Home Possible Advantage mortgages are offered by Freddie Mac to low- and moderate-income borrowers. Eligible properties for Home Possible mortgages are one- to four-unit homes, condos, planned unit development homes (PUD) and manufactured homes. These mortgages require a 3% down payment, have fixed or adjustable rates and carry a term of up to 30 years.

Home Possible and Home Possible Advantage loans differ in the properties they finance, rate pricing adjustments, loan-to-value ratio (LTV) for each property and loan amounts.

Government loans

When a government agency, such as the Federal Housing Administration (FHA), Department of Veterans Affairs (VA) or the U.S. Department of Agriculture (USDA), insures a home loan that is issued by a private lender, that mortgage is considered a government or government-backed loan.

All government-backed loans are within maximum conforming loan limits, which is $548,250 in most areas (up to $822,375 in high-cost areas) for 2021.

The conforming loan limit is $548,250 for most of the U.S. in 2021.

FHA loan

FHA loans are insured by the Federal Housing Administration. These mortgages are intended for low- and moderate-income homebuyers. FHA loan lenders are appealing to first-time homebuyers because they require lower down payments and credit scores than conventional loans.

VA loan

VA loans are guaranteed by the Department of Veterans Affairs but granted by private VA lenders, like banks and mortgage companies. To receive this loan, you have to meet certain eligibility requirements set by the VA, primarily based on the type of service and length of time served.

USDA loan

USDA loans are designed to promote homeownership in rural areas. These loans are guaranteed by the U.S. Department of Agriculture and available for low- to moderate-income buyers to buy a single-family home in qualifying locations. They have low, fixed rates and flexible credit requirements. USDA lenders typically don’t require a down payment.

Nonconforming loans

In 2021, loans of more than $548,250 (for a single-family home, in most areas) are considered nonconforming “jumbo” loans.

Nonconforming loans generally require larger down payments and come with higher mortgage interest rates than conforming loans. However, you can borrow a larger amount than with a conforming loan.

These loans are issued by private jumbo lenders, such as banks and other financial institutions. The private lenders set their own rules on requirements and approval and typically hold the loans as investments.

Jumbo loan

Jumbo loans, a type of nonconforming mortgage, are for amounts higher than the limits set by Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac.

Super jumbo loan

Super jumbo loans are intended for buyers who want to acquire bigger and more expensive homes. The loan limits are higher than those of jumbo loans and carry fixed or adjustable rates. The down payment normally ranges between 10% and 20%. To qualify, borrowers must have large incomes and assets, excellent credit history and low debt-to-income ratios.

Pros

  • Higher borrowing amounts
  • Competitive interest rates
  • Variety of loan terms, like fixed or adjustable rates

Cons

  • Higher down payments
  • Stricter credit requirements
  • Higher closing costs and fees

Fixed-rate mortgages

Fixed-rate mortgages are loans that have the same interest rate for the life of the loan. If you get a fixed-rate mortgage, you'll always pay the same rate until the loan is paid off in full. Most borrowers opt for fixed-rate mortgages because they are more predictable and stable. Fixed interest rates are best for borrowers who buy a home while interest rates are low.

  • 30-year fixed mortgage: A 30-year fixed-rate mortgage loan has a fixed interest rate for the 30-year duration of the loan. However, you do have the flexibility to repay your loan faster with multiple monthly payments in a single month or paying it off in a lump sum.
  • 15-year fixed mortgage: Your interest rate on the mortgage will remain the same for the 15 years of the loan term. You can always pay back the loan faster.

Adjustable-rate mortgages

Adjustable-rate mortgages (ARM) are home loans with interest rates that change based on market conditions. An ARM will have one rate for a period of time and then adjust based on market conditions and your loan agreement. Most of the time, adjustable interest rates fluctuate monthly, quarterly, annually or every three or five years.

For example, a 5/1 ARM will have a fixed rate for the first five years of the loan and then adjust once per year after that; a 7/1 ARM is fixed the first seven years and followed by yearly adjustments. Adjustable-rate mortgages are generally considered to be riskier for the borrower because of their volatility.

Pros

  • Low repayments during fixed interest rate phase
  • Payments can decrease
  • Caps on rates and repayments

Cons

  • Rate can go up over time
  • Payments can increase
  • More complex loan terms

Renovation loans

If a homebuyer wants to purchase a house that needs some work, they can borrow money for the necessary renovations at the same time they are taking out money to buy their house. Combining the loan needed to purchase a home with the loan needed to renovate the home is convenient. You can also get a renovation loan for a home you already own.

There are three types of renovation loans:

203(k) loan

A 203(k) loan combines the purchase of a home and the cost of renovations into one loan — or you can use the 203(k) program to rehabilitate an existing home. The cost of the renovations must be at least $5,000, and the home value must be within FHA limits. You can use a 203(k) loan to make structural alterations, eliminate health and safety hazards, replace roofing, replace plumbing, improve energy conservation or enhance accessibility.

HomeStyle loan

Fannie Mae HomeStyle loans provide funds to borrowers for renovations, repairs or improvements at the time of purchase or refinance. You work with a contractor to develop plans and then submit them to the lender for approval.

ChoiceRenovation loan

A ChoiceRenovation loan from Freddie Mac lets you roll the purchase price and renovation costs into one single closing transaction. ChoiceRenovation loans can be used with fixed- or adjustable-rate loan products.

Home equity and refinance loans

A refinance loan replaces your existing mortgage with a new one. Home refinance loans are useful to homeowners who want to lower their monthly mortgage payments, reduce their interest rate or switch from an adjustable-rate to a fixed-rate loan. A cash-out home refinance loan allows you to borrow more than you have remaining on your principal balance and use the extra cash however you want.

Home equity loans and home equity lines of credit are types of second mortgages, which add another payment to your existing mortgage.

Here are the major types of home refinance loans and second mortgages:

  • Rate-and-term refinance: With a rate-and-term refinance, you get a new mortgage with a different interest rate and/or term length. The result might be a lower monthly mortgage payment or paying less in interest.
  • Cash-out refinance: In a cash-out refinance, you get a new mortgage for an amount that’s higher than your principal balance; you can use the extra cash for any purpose.
  • Home equity loan: A home equity loan, a type of second mortgage, allows homeowners to borrow against the equity in their home and pay the money back over time.
  • Home equity line of credit (HELOC): With this type of second mortgage, your bank sets up a revolving line of credit — like with a credit card — and you can borrow up to a limit that’s based on your home equity. You pay back only what you borrow.

Another type of mortgage is a reverse mortgage, which some older homeowners use to supplement their income. In a reverse mortgage, a homeowner gets a lump sum or regular payments from a lender in exchange for equity in their home. The loan is due back only when the borrower dies or sells the property.

For more information, read about the differences between reverse mortgages, home equity loans and HELOC.

Which mortgage is right for me?

The best type of mortgage for you is primarily based on whether you meet the eligibility requirement of a conventional or government loan, the type of interest rate you prefer and the total amount you need to borrow.

Conforming vs. jumbo mortgages

First, figure out how much you need to borrow.

  • If you need to borrow less than $548,250: A regular conforming loan works. You can get conforming loans from both conventional and government lenders. With a conforming loan, you'll typically be able to make a lower down payment or pay a lower interest rate than with a nonconforming loan that is not backed by a government-sponsored enterprise (GSE).
  • If you need to borrow more than $548,250: Jumbo (nonconforming) mortgages are best for those who want to buy a really expensive house — and also have the credit score to qualify. Generally, nonconforming loans are best for high-income homebuyers who want to borrow above the limits of conforming loans and are willing to make a larger down payment.
Most mortgages have a fixed rate and a 30-year term.

Conventional loan vs. FHA and other government-backed loans

Next, you need to determine if you qualify for a conventional loan or government-backed mortgage.

  • If you have a strong credit history: Conventional mortgages are usually best for prospective homebuyers with a strong credit history, stable income and the ability to make a down payment of at least 5%. Conventional mortgage loans can be used to finance a primary residence, secondary home or investment property.
  • If you have low to moderate income: Government-backed mortgages are typically easier to qualify for than conventional mortgage loans. They have more relaxed lending guidelines and payment terms.

Fixed-rate vs. adjustable-rate mortgages

Depending on what type of mortgage you get, you might have a choice between a fixed or adjustable interest rate. Your interest rate will vary based on factors such as your credit history, the type of loan and the amount you’re borrowing.

Figuring out if you want a fixed or adjustable rate often comes down to what interest rates are available to you at the time of purchase. Depending on your finances, a lower initial rate on an ARM might not be worth it if it increases in a few years and you're not financially prepared to cover it.

Keep in mind that you can usually lower a fixed rate by shortening the length of time on the mortgage terms by five or more years.

  • If you plan to keep the house for a long time: A 30-year fixed-rate loan is a safe option if you don’t plan to move for a while because payments are more predictable. It’s also best for homebuyers with moderate monthly incomes who cannot afford to pay suddenly higher monthly mortgage payments.
  • If you plan to sell in the next few years: Sometimes, an ARM is a better deal if you don’t plan to stay in your home long — you benefit from a lower rate and get out of the loan before the rate changes.

Bottom line

Understanding the different types of mortgage loans available is an important early step in choosing the best home loan for you or your family. The best type of mortgage for you will depend on factors like your credit score, income level and loan term preferences.

If a traditional home loan isn't quite right for you, you can also look into owner financing. After you review the types of mortgages, you'll need to understand how to get a mortgage.

Make sure you also compare multiple lenders so you get the best rate on your new home. It’s a relatively easy process, especially if you work with an online mortgage lender.

ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. To learn more about the content on our site, visit our FAQ page.
  1. U.S. Department of Housing and Urban Development (HUD), “FHA Mortgage Limits.” Accessed Jul 9, 2021.
  2. Federal Housing Finance Agency (FHFA), “Programs.” Accessed Jul 9, 2021.
  3. Fannie Mae, “Know Your Options.” Accessed July 9, 2021.
  4. Freddie Mac, “Mortgage Products.” Accessed July 9, 2021.
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Profile picture of Michele Lerner
by Michele Lerner Mortgage & Real Estate Contributing Editor

Michele Lerner, author of “HOMEBUYING: Tough Times, First Time, Any Time”, has been writing about personal finance and real estate for more than two decades. Michele writes for regional, national and international publications in print and online for a variety of audiences including consumers, real estate investors, business owners and real estate professionals.