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 mortgage loan, your property is used as collateral, meaning that the lender has the right to foreclose your house to recoup their funds if you fail to repay the loan within specific agreed-upon terms.
What are the different types of mortgages?
There are many types of mortgages for homebuyers. They can all be categorized first as conventional, government or nonconforming loans, and then as fixed- or adjustable-interest rate loans. Refinance and renovation loans are considered second mortgages because they are loans taken out against a property that already has a mortgage.
- 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. These loans often have more lenient eligibility requirements compared to conventional loans.
- Conventional loans: Conventional loans are mortgages issued by private lenders that are not guaranteed by the federal government. Conventional mortgage loans are further classified as either conforming or nonconforming, depending on if they conform to federal mortgage loan limits set by the Federal Housing Finance Agency (FHFA).
- Nonconforming loans: Nonconforming loans are mortgage loans that are above the federal conforming loan limits. These loans are also sometimes called portfolio loans since they have to stay on lenders’ books and can’t be sold to the government. Nonconforming loans can also be called “jumbo” loans because they are available for higher amounts than conforming loans.
- Home renovation loans: Renovation loans are commonly taken out by both homeowners and home buyers. If a home buyer wants to get 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 loans needed to purchase a home with loans needed to renovate the home often gets you a better deal overall.
- Home refinance loans: Home refinance loans are a way for homeowners to pay off their current mortgage with a new loan. Often, home refinance loans are a way to lower monthly payments and reduce interest rates.
Which mortgage is right for me?
The best type of mortgage for you will primarily be determined by whether or not you meet the eligibility requirement of a conventional or government loan, the kind of interest rate you prefer and the total amount of the loan you need to borrow.
Government-backed vs. conventional mortgage loans
First, you’ll need to determine if you qualify for a conventional loan or government-backed mortgage. A conventional loan is privately funded and offered by a bank or credit union. It is not federally guaranteed or insured. If a loan is guaranteed by a federal agency, then it is considered a government-backed loan. Generally, government-backed mortgages are easier to qualify for than conventional mortgage loans. Both conventional and government-backed loans can be available with fixed- or adjustable-interest rate options, depending on lender programs.
- Government-backed mortgages have more relaxed lending guidelines and payment terms. They are ideal for low- and moderate-income borrowers with average financial profiles and credit scores. Some programs exist for specific groups or areas, like the USDA loan for rural development or VA loans for veterans. Government-backed loans usually come with fixed interest rates, but not always.
- Conventional mortgage loans tend to have higher interest rates than government-backed loans, and their terms vary depending on the size and length of the loan, borrower’s financial profile and the financial market’s current condition. Conventional loans are usually sought after by moderate- to high-income earners and are available for financing investment properties and second homes.
Fixed-rate mortgages 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 determine the amount you pay your lender in addition to the amount of the loan, or principal. 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. Also, 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.
- Fixed-rate mortgages are loans that have the same interest 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—the interest rate is known at the time of issue, and the installment payments remain constant. 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.
- Adjustable-rate mortgages (ARM) are home loans with interest rates that change based on market conditions. An adjustable-rate mortgage (ARM) will have one rate for a period of time and then reset based on the condition of the housing market. Most of the time, the adjustable-interest rate will fluctuate monthly, quarterly, annually or once every three 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-interest rate mortgages are generally considered to be more risky for the borrower.
Conforming vs. nonconforming loans
Whether you need a conforming or nonconforming loan will likely be determined by how big of a loan you need. A conforming loan is a mortgage for any amount within the federal loan limit and is secured by the government. This doesn’t mean it’s impossible to get a loan above the conforming limit, just that the loan will be nonconforming and therefore won’t be securitized by Fannie Mae or Freddie Mac.
- Conforming loans are mortgages for amounts that are within the conforming limit set by the Federal Housing Finance Agency. The FHFA set conforming loan limits at $484,350 in most parts of the country and $726,525 in some high-demand housing markets for 2019. All conforming loans fall within these maximum loan limits. Generally, with a conforming loan, you’ll 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 GSE. Most first-time home buyers get conforming loans.
- Nonconforming loans are mortgages that exceed federal conforming limits and cannot be secured by a government-sponsored enterprise (GSE) such as Fannie Mae or Freddie Mac. For instance, if you need to mortgage a house in an area with much higher than average median housing prices, your only option might be to take out a loan for an amount greater than federal conforming limits. Nonconforming loans are best for high-income homebuyers who want to borrow above the limits of conforming loans and are also willing to pay higher interest or make a larger down payment.
Government-backed home loans make homeownership possible for borrowers with lower credit scores and less savings built up for a down payment if they meet other minimum eligibility requirements. The most common types of government mortgages are backed by the Federal Housing Administration (FHA), U.S. Department of Veterans Affairs (VA) or the U.S. Department of Agriculture (USDA). All government-backed loans are within maximum conforming loan limits.
- FHA loan
FHA mortgages are loans intended for low- and moderate-income home buyers. There are different types of FHA loans, but they are all insured by the Federal Housing Administration and issued by lenders approved by the FHA. FHA loans are appealing to first-time home buyers because they require lower down payments and credit scores compared to conventional loans.
- VA loan
VA loans are mortgage loans available to people who have served or are serving the military, including surviving spouses who have not remarried. These loans are guaranteed by the Department of Veterans Affairs but granted by private lenders like savings and loan associations, banks and mortgage companies. To receive this loan, you have to meet certain eligibility requirements set by the VA, primarily on the type of service and length of time you have served.
- USDA loan
USDA home loans are available for low- to moderate-income buyers to buy a single-family home in qualifying rural and suburban areas. USDA loans have low fixed rates, flexible credit requirements and require no down payment.
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 percent. Conventional mortgage loans can be used to finance a primary residence, secondary home or an investment property.
- Conventional 97
Conventional 97 loans are loans offered by Fannie Mae to low- and moderate-income home buyers for an amount up to 97 percent 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. They come in two programs. One is the HomeReady program and the other is the Fannie Mae Standard, offered to first-time buyers.
HomeReady is one of two loan programs offered by Fannie Mae to low-income buyers who need to buy or refinance a home. It requires a lower down payment and borrower contribution, more affordable mortgage premiums and flexible approval process. It allows family members or friends to co-sign on your loan and considers income from other household members for loan approval. To qualify, you must meet a preset income limit requirement, which is typically income equal to or less than the area median income, a minimum credit score of 620 and participation in homeownership education.
- Home Possible + Home Possible Advantage
A Home Possible mortgage is offered by Freddie Mac to low- and moderate-income borrowers to buy a home. Eligible properties for Home Possible mortgages are 1- to 4-unit homes, condos, planned unit development homes (PUD) and manufactured homes with certain restrictions. These mortgages require a down payment of as low as 3 percent, have fixed rates and carry a term of up to 30 years. Home Possible and Home Possible Advantage loans differ in the eligible properties they finance, rate pricing adjustments and loan-to-value ratio (LTV) for each property and amount of loan.
Nonconforming loans are conventional loans that are available for higher amounts than conforming loans. Since you won’t be bound by Fannie Mae or Freddie Mac, terms and conditions can vary drastically by lender, and you’ll typically pay higher rates than with conforming loans because they are riskier to the lender. Nonconforming loans require a down payment of at least 20 percent and typically come with a higher mortgage interest rate than conforming loans, but you’ll be able to get a larger amount. The most common types of nonconforming mortgages are jumbo loans.
- Jumbo loan
Jumbo loans are home loans with larger conforming limits than those set by Fannie Mae and Freddie Mac. Jumbo loans are issued by private lenders such as banks and other financial institutions. The private lenders set their own rules on requirements and approval and normally hold the loans as an investment.
- 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 percent. Interest rates may be higher or lower than those of conforming mortgages depending on market conditions. To qualify, borrowers must have large incomes and assets, excellent credit history, high credit scores and a low debt-to-income ratio.
If you already own your home and would like to make expensive improvements or repairs, you can also get a renovation loan from your current lender or a new lender. In this case, you’ll pay on the renovation loan separate from the mortgage loan you took out to purchase your house.
- FHA 203k renovation loan
An FHA 203k renovation loan is an FHA-insured mortgage issued by private lenders to borrowers to purchase a home and finance renovation. It may also finance temporary house rent while construction is ongoing. It comes with a 3.5 percent down payment, either a fixed or variable rate and a repayment term of up to 30 years. Interest rates vary depending on the borrower’s credit history and score. A monthly upfront mortgage insurance premium is required, and an origination fee may be charged. Owners of homes are qualified, but real estate investors and house flippers are not. Luxurious renovations, such as pools, are not covered by FHA 203k.
- Streamlined-K mortgage loans
A Streamlined-K mortgage loan is a type of FHA 203k loan that only covers minor renovation work such that household members can live in the home while the renovation is ongoing. Major structural work, such as adding new rooms, wings or floors, are not covered. The loan limit is $35,000.
- HomeStyle renovation mortgage
A HomeStyle Renovation mortgage is a loan backed by Fannie Mae to be used primarily to purchase and renovate a home as a primary residence of the borrower. It is also open to small buy-and-sell investors looking to buy a single-unit investment property. Loan amounts typically range from 65–95 percent of a property’s purchase price, which means they require a down payment of 5–35 percent. Repayment terms vary from 15 to 30 years. Renovations must start within 30 days of approval and be completed in six months. DIY projects are allowed provided the project cost is less than 10 percent of the after-repair-value.
- Freddie Mac renovation mortgage
A Freddie Mac renovation mortgage can be used for the purchase and renovation of a new or second home or renovation to an existing 1–4-unit site-built home. It is available in 15-, 20- and 30-year fixed rate mortgages. Manufactured homes are not eligible.
Home refinance loans
Getting a home refinance loan can help you pay off your mortgage faster. Home refinance loans are available to homeowners who want to lower their monthly payments and reduce interest rates or switch mortgage programs from an adjustable rate to a fixed-rate loan. Home refinance loans typically reset your loan’s value.
- Home equity loan
Home equity loans allow homeowners to borrow against the equity in their home. Home equity is the difference between the current market value of a home and the remaining amount of mortgage on that home. Home equity loans can be used to finance major home repairs or family expenses such as college education or medical bills. They are provided in a lump sum payment equivalent to 80 to 90 percent of the home equity on fixed but competitive rates.
- Home equity conversion mortgage
A home equity conversion mortgage (HECM) is an FHA reverse mortgage program that allows seniors to get cash from their home equity. The loan amount is based on the appraised value of the home and subject to FHA limits. Interest accrues on the loan balance but payment is not required until the property is sold or the borrower dies, in which case the heirs will pay off the loan. To qualify, you must be at least 62 years old, live in an FHA-approved property, meet financial eligibility requirements as set by HUD, not be delinquent on any federal debt and attend a session with an HUD-approved HECM counselor.
HELOC, or home equity line of credit, is a type of second mortgage on your home equity that can be withdrawn on a staggered basis during a set draw period, typically up to 10 years. Interest is variable and depends on the benchmark market rate the lender uses. You can opt to pay only the interest or the interest plus principal during the draw period. When the draw period expires, you can start repaying your loan for up to 20 years.
- Cash-out refinance
Refinancing is a mechanism available to borrowers who want to replace their existing mortgage for a new and larger one by using their home equity. Cash-out refinance allows them to finance major repairs or refurbishments. Many borrowers also use this method to negotiate for better terms on their mortgage, such as lower interest rates, lower monthly payments, shortened or extended paying periods and more.
- Reverse mortgages
A reverse mortgage is an FHA-insured loan intended for seniors who are at least 62 years old to help cover basic living expenses. It can be drawn from the borrower’s home equity. After receiving the proceeds of the reverse mortgage, the borrower must pay the balance of the existing mortgage. Borrowers are not required to pay back the reverse mortgage as long as they live in the home, provided they remain current on property taxes, home insurance and homeowners association dues. Upon the death of the borrower, the heirs can either pay the reverse mortgage or sell the home and pay the reverse mortgage. Whatever is left of the sale proceeds goes to the heirs.
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