What are the different types of mortgages available?
One, if not the biggest purchases you will make in your life will be your home. If you are going to borrow some of the money to fund the purchase, one of the first steps will be to evaluate the various mortgage options available.
This research is important to ensure that you find the right solution for your particular financial situation and to pick the most cost-effective option. In addition, reviewing the different options will give you a sense of what to expect when you apply. We understand that mortgage products are continuously changing. We at Ultra Mortgage are on hand to give you the best advice and guidance to help you choose the right one for you.
Conventional Loan
If you have a good credit score and can make a reasonable down payment on your home, a conventional mortgage may be a good choice for you. The 30 year fixed rate conventional mortgage is the most popular option for homebuyers.
There are two types of conventional loans available, conforming loans and non-conforming loans. Conforming loans meet the standards set by the Federal Housing Finance Agency (FHFA). These standards apply to the credit, debt and loan size of the mortgage. You can check the latest conforming loan limits in our recent Mortgage Monday post here.
Non-conforming loans do not meet the standards mentioned above. These mortgages are targeted at borrowers who are looking to purchase more expensive homes or people who have unusual credit profiles.
Pros and Cons of conventional loans
Conventional loans can be used for a variety of reasons including the purchase of a primary home as well as a second or investment property. The borrowing costs for a conventional mortgage tend to be lower than other types of mortgages, even if interest rates are slightly higher.
In addition, with a conventional mortgage, you can ask your lender to cancel private mortgage insurance (PMI) once you reach 20% equity. Also, the downpayment on these loans can be as low as 3% for loans backed by Fannie Mae or Freddie Mac.
On the other hand, these loans have a minimum FICO score of 620 or higher and also require a higher down payment than some government loans. The debt-to-income (DTI) ratio can be no higher than 43% to 50% in some cases. There will also likely be a need to pay PMI if your down payment is less than 20%. Finally be prepared to produce a significant amount of documentation to verify your income, assets, employment and down payment for this type of loan.
Jumbo Loan
If you are looking to purchase a home where the price exceeds the latest conforming loan limits, a jumbo loan is likely to be the best option.
Jumbo mortgages are loans that do not fit within the FHFA borrowing limits mentioned above (see conforming conventional mortgages). These loans are more common in areas that have home prices higher than the national average (for example, San Francisco, New York and Los Angeles).
Pros and Cons of jumbo loans
Jumbo mortgages enable the purchaser to acquire a more expensive home with interest rates that are competitive with other conventional loans. In addition, these loans may be the only option for some buyers to move forward with their home purchase if they are looking in areas with very high home values.
Note that these mortgages require a down payment of 10% to 20% in many cases and require a FICO score of 700+. Also, the DTI ratio cannot be higher than 45% and you will need to show that you have significant assets in terms of cash or other savings. Finally, the documentation requirements for these loans can be more in depth than other types of loans.
Government-Insured Loan
If your credit score does not meet the requirements for the other types of loans or you do not have much to put towards a down payment, this type of loan could be a viable option. VA-backed loans are often a better choice for military service members, veterans and eligible spouses.
The US government does not provide mortgages but it does play an important role in paving a road to home ownership for more Americans. There are three government agencies that back mortgages.
The Federal Housing Administration (FHA)
The US Department of Agriculture (USDA)
The US Department of Veterans Affairs (VA)
FHA Loans
Loans backed by the FHA come with competitive interest rates. They are better for homebuyers that do not have a great credit score or a large down payment. The minimum FICO requirement is 580. This credit score will let you take advantage of the FHA maximum of 96.5% financing with 3.5% down payment.
However, a score as low as 500 will be accepted with a 10% down payment. FHA loans do require two mortgage insurance premiums so the overall cost of the mortgage can be higher. Also note that the home seller is allowed to contribute to closing costs with an FHA loan.
USDA Loans
Loans from the USDA are suitable for buyers in rural (USDA eligible) areas who have moderate to low incomes. Some of these loans do not require a down payment but they do attract additional fees (including an upfront fee to the value of 1% of the loan amount).
VA Loans
These loans provide flexible, low-interest mortgages for members and veterans of the US military as well as their families. There is no minimum down payment, mortgage insurance or credit score requirement. In addition, closing costs are generally capped and can be paid by the seller. VA loans do come with a funding fee equal to a percentage of the loan amount. This can be paid upfront, at closing or rolled into the loan cost.
Pros and Cons of Government-insured loans
These loans can be useful if you don’t qualify for a conventional loan as the credit score requirements are lower. They also don’t require a large down payment and are available to repeat and first time buyers. In addition, VA loans do not require a down payment or mortgage insurance.
However, note that mortgage insurance premiums on FHA loans cannot be canceled unless refinancing into a conventional mortgage. The loan limits on these FHA loans are lower and this may therefore limit your property purchase options. You must live in the property that you are buying to qualify for this type of mortgage and the loan could have higher overall borrowing costs. Finally, be prepared to produce more documentation depending on the loan type.
Fixed Rate Mortgage
Planning to stay in your home for five to seven years and want to avoid any changes to your monthly payments? A fixed rate mortgage might be your best option.
A fixed rate mortgage keeps the same monthly payments over the life of the loan. Fixed rate loans typically come with terms of 15 or 30 years although some lenders may be more flexible with terms between 8 and 30 years.
Pros and Cons of Fixed Rate loans
With this type of mortgage, the monthly payments stay the same throughout the life of the loan. This makes it much easier to include the loan expense in your monthly budget.
However, if interest rates go down, you would have to refinance to take advantage of the lower rate. In addition, the interest rates for this type of loan are typically higher than adjustable rate mortgages.
Adjustable Rate Mortgage (ARM)
Not planning to stay in your home for more than a few years? An adjustable rate mortgage (ARM) could help you save on interest payments. However, you should be conscious of the level of risk you undertake with this type of mortgage as your payments might increase if you are still in the home if or when interest rates rise.
ARM loans have interest rates that change based on the market conditions. Many ARM products have rates that are fixed for a certain number of years before changing to a variable rate. For example, a 7 year / 6 month ARM will remain fixed for the first 7 years. After that, the rate will adjust every 6 months. Therefore, with these loans, it’s important to know how much that rate could change and what your payments could be after the fixed rate period expires.
Pros and Cons of Adjustable Rate loans
ARMs can provide a lower rate for the first few years after the initial purchase and they can save you a substantial amount of money on interest payments.
However, the monthly payments can change so you must be aware of the potential impact on your monthly repayments. Also, if you plan to sell your house before the interest rates switch to variable, you need to monitor local house prices to ensure you time this sale correctly.
Summary
There are many different options available to the potential home-owner when it comes to financing a house purchase. It’s important to understand all of the options available to ensure that you choose the best fit for your personal circumstances.
The most common mortgage types have been detailed above but there are other options available such as construction loans, interest only mortgages, piggyback loans and balloon mortgages. The mortgage market is constantly changing and therefore it is useful to talk to someone who is familiar with the details of each option.
Ultra Mortgage prides itself on its streamlined lending process and taking the stress out of home loans. We have expert knowledge when it comes to home loan choices so talk to us today to discuss finding the right mortgage option for you.