What types of mortgage loans are available to you?

Published October 6, 2020
by Better

types of mortgages

If you're like most homebuyers, you’ll probably need a loan to fund the purchase of your home. But shopping for a mortgage is a lot like shopping for a home—there are different options that cater to different needs, and you’ll want to find the one that fits your financial priorities. While all mortgages share the same purpose—funding the purchase of property—they each come with different advantages, disadvantages, and unique terms. Ultimately the type of home loan you choose will have a tremendous impact on your future mortgage payments and overall financial health.

The types of home loans you’re likely to encounter fall into two general categories: conventional mortgage loans and government-backed mortgage loans. While Better currently only offers conventional loans, it’s still good to review all the options that might be available to you through different lenders and weigh the benefits and costs of each.

Conventional mortgage loans

A conventional mortgage is offered by a private lender—such as a bank or a mortgage company—rather than a government-sponsored enterprise, such as the Federal National Mortgage Association (commonly known as Fannie Mae) or the Federal Home Loan Mortgage Corporation (commonly known as Freddie Mac). Most of these mortgages are what’s known as “conforming,” as they still adhere to the Federal Housing Finance Administration’s (FHFA) loan limits and meet Fannie Mae and Freddie Mac requirements. However, there is a subcategory of conventional mortgages called “nonconforming,” which are less standardized.

Fixed-rate mortgages

Fixed-rate mortgages are the most common kind of conventional loan—allowing you to borrow a set amount of money and pay it back in monthly installments. These loans have an unchanging or “fixed” interest rate until you sell or refinance your property, and most come with a 15- or 30-year loan term (though other lengths are available). Fixed-rate mortgages are ideal if you prefer predictable monthly payment amounts. They allow you to more accurately budget for other expenses without having to worry about housing market fluctuations impacting the cost of your mortgage.

There are pros and cons regarding the length of a fixed-rate mortgage, which refers to the amount of time you have to pay back your loan. For example, 15-year loans typically offer lower overall costs but higher monthly payments. While you’ll pay less money in the long run with a 15-year loan (thanks to fewer interest payments and a reduced interest rate) your monthly mortgage payments will be higher since you will be paying off the loan within a shorter period. Borrowing the same amount with a 30-year loan means you will pay smaller monthly installments, but the additional 15 years of interest fees as well as a higher interest rate will result in you paying more throughout the life of your loan. Better Mortgage currently offers this type of loan and competitive interest rates.

Adjustable-rate mortgages (ARMs)

Fixed-rate mortgages are pretty straightforward, but what about adjustable-rate mortgages? The fundamental difference between the two is that ARMs only have a fixed interest rate for the first few years of the loan term. After that, your interest rate resets to reflect market conditions at specified intervals. For example, a 5/1 ARM has a fixed interest rate for the first 5 years and is subject to market fluctuations every year after that.

Adjustable-rate mortgages might work for you if you plan to relocate sooner rather than later, and only need the loan (and that stable interest rate) for a few years. It’s also possible that you’ll pay less per month if market rates work in your favor once they become adjustable. However, ARMs are risky bets. Your interest payments might be much higher when the first few years of your mortgage are up, which can cause financial strain—especially if you lose your source of income or the economy suffers. Some ARMs also charge prepayment penalties that make it difficult to refinance or sell your home within the first few years of living in it. Better Mortgage currently offers this type of loan.

Interest-only mortgages

Monthly mortgage payments traditionally include two components: principal, which is the original amount of money you borrowed from your lender, , and interest, the cost of borrowing that money. When it comes to interest-only mortgages, you have the option to only pay the interest portion of your monthly bill for the first few years of your loan. However, once this period is over, you then need to pay back the principal amount—which means your monthly payments will increase dramatically due to the delay in repayment.

Interest-only mortgages can be useful if you have variable income (if you work on commission, for example) but there are drawbacks to taking out an interest-only mortgage. For one thing, it can be difficult to qualify for this type of loan. They also increase the time it takes for you to pay back the loan. Interest-only mortgages played a significant role in the 2007 housing crisis, because they encouraged homebuyers to qualify for loan amounts beyond what they would have otherwise been able to borrow. Better Mortgage does not currently offer this type of loan.

Jumbo mortgages

A jumbo mortgage exceeds the federal loan limits set by the FHFA, making it a nonconforming conventional mortgage (try saying that five times fast). To put it simply, if you want to borrow more than the government-set limit—which is currently $510,400 in most counties—you may consider taking out this kind of mortgage.

Jumbo mortgages are advantageous for purchasing a high-end home in an expensive area, but they’re considered riskier for the lender because they do not come with government protections if a borrower defaults. As such, jumbo loans enforce stricter qualification standards: you must have a minimum credit score of at least 700 and a low debt-to-income (DTI) ratio. Different lenders will have unique criteria—and some may be more flexible than others—but many require you to have a maximum DTI of 45%.

Your chances of qualifying for a jumbo mortgage are higher if you have plentiful cash reserves, but you should be prepared to pay a more substantial down payment and lock in potentially higher interest rates than you would with a conforming loan. Better Mortgage currently offers this type of loan.

Government-backed mortgage loans

The U.S. government does not directly loan money to homebuyers, but there are multiple government agencies that purchase loans from private lenders. These are designed to make homeownership more accessible to borrowers with less-than-perfect credit scores and little to no savings. Some government-supported loans include:

FHA loans

The Federal Housing Administration (FHA) insures loans from an approved list of lenders in the event that their borrowers default. FHA loans are particularly advantageous for homebuyers who cannot afford a steep upfront cost because they require as little as a 3.5% down payment.

FHA loans are popular amongst first-time homebuyers, and you don’t need to have an exceptional credit score to qualify (the minimum is 580 to qualify for a 3.5% down payment). The FHA aims to help more people become homeowners, but there are a few conditions. First, you can only borrow so much (between $$356,362 and $822,375 depending on your state and the number of people in your family). Second, you are required to pay a mortgage insurance premium (MIP). This upfront premium, which is usually equivalent to around 1% of the loan’s value, can be paid upfront or over the life of the loan. Better Mortgage currently offers FHA loans for homebuyers.

USDA loans

Loans issued through the United States Department of Agriculture’s (USDA) loan program are meant for families who live in rural areas. They are advantageous for low to mid-income applicants who do not qualify for other kinds of mortgages due to a low credit score or a high DTI. The government finances the entirety of a USDA-eligible home’s value, meaning borrowers do not need to make a down payment in order to purchase the property. Similar to FHA loans, the USDA partners with local lenders and insures loans that are part of its program. Because local lenders have been guaranteed repayment even if borrowers default, they are able to offer low interest rates.

If you live in a rural area and are considering a USDA loan, keep in mind that you will have to purchase mortgage insurance. Another significant eligibility factor is that your other debts cannot exceed 41% of your total income. Better Mortgage does not currently offer this type of loan.

VA loans

Department of Veterans Affairs loans are for, as you might have guessed, U.S. veterans. They are also available to eligible service members or the spouses of service members who died in the line of duty or have a service-related disability. VA loans do not require a down payment or mortgage insurance. They also come with no prepayment penalties—which allows you to pay off your loan faster if you’re in a position to do so. The Native American Direct Home Loan program offers unique terms to Native American veterans and their spouses.

Unlike conventional loans, you will also have to pay a one-time VA funding fee if you qualify, which goes directly toward keeping the program running. Better Mortgage does not currently offer this type of loan.

Finding the right mortgage for you

As you can see, there is no one-size-fits-all mortgage solution. You have to do your research to figure out which has the best terms for your financial situation, including the monthly affordability of the loan, your down payment savings, and how long you anticipate living in your home.

Better Mortgage offers both fixed and adjustable rates for conventional and jumbo loans. We can also finance a whole range of properties, including single-family homes, multi-family homes, townhouses, and more. Get pre-approved today, and we’ll help you find the perfect mortgage for your needs.

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