The 7 Most Popular Mortgage Types For Home Buyers
There are several types of mortgage loans that appeal to a wide range of borrowers with unique housing needs and financial circumstances.
This list provides an overview of interest rates, qualified borrowers, and the potential pros and cons for each type of loan.
1. Fixed rate mortgage or classic mortgage loan
About 90% of homebuyers choose a 30-year fixed rate loan, making it the most popular type of mortgage in the country.
As the name suggests, the interest rate has not changed over the past 30 years. This means that borrowers can benefit from lower monthly payments because the mortgage is stretched over a long period.
This arrangement also protects homeowners from potentially drastic spikes in monthly payments due to fluctuations in mortgage rates. However, you will pay more interest over the life of the loan.
Most lending institutions also offer 15 and 20 year mortgage terms – however, borrowers will have to repay the principal on a shorter period, so monthly payments will be considerably higher.
The advantage of short term loans is their lower interest rate. Each mortgage payment pays off more of the principal, so 15- and 20-year loans cost much less overall.
Read more: 7 questions asked by first-time homebuyers that every broker should answer
2. Variable rate mortgage (ARM)
An ARM home loan begins with a rate that remains constant for a specified period of time, but changes to an adjustable interest rate for the remainder of its term.
Also called a âteaserâ rate, it is initially set below the market rate for most comparable fixed loans. However, it is expected to increase at regular intervals called the frequency of adjustment. According to Freddie Mac, ARMs will exceed fixed rates if they are held long enough.
ARMs are significantly more complex than fixed rate loans because the adjustments are tied to indexes like treasury bills or certificates of deposit.
When signing your loan, borrowers agree to pay at a rate that may be slightly higher than the adjustment index. You also agree to a cap or the maximum rate that the mortgage can reach throughout its life.
ARMs start out much cheaper than fixed rate mortgages, at least for the first three to seven years. However, monthly payments can change frequently, and subsequent adjustments will follow current market rates – not the initial below market value.
Fixed rates are relatively safer and more predictable for the most part, but variable rates can be beneficial for short-term homeowners who plan to move in a few years.
3. Interest-only mortgage
Fixed rate and ARM loans require monthly payments to amortize both principal and interest. In contrast, interest-only loans require borrowers to pay interest only for the first few years of the term.
Once the initial period is over, the borrower will start paying interest and principal. You can generally see interest-only loans as an ARM repayment structure.
For example, a borrower will only pay interest for the first 10 years of an ARM 10/1 agreement. After the 10th year, the rate will adjust each year and you will also start paying the principal.
The bottom line is that interest-only loans are very complex and are not recommended for most borrowers. You can take advantage of low monthly payments during the interest-only period, but the costs will increase dramatically after it ends.
4. Jumbo mortgage
Jumbo mortgages are loans that exceed the amounts set annually by the Federal Housing Finance Agency (FHFA).
You need a jumbo loan if the property you want to buy exceeds $ 548,250 in 2021. The limit is $ 822,375 for high cost locations like parts of California and Washington, DC.
If the price does not meet FHFA thresholds, you must have a solid credit score of 680 or higher. In addition, the lender may ask you to put up to 12 months of mortgage payments on a cash reserve.
Since you are borrowing a large amount, additional fees may result in higher closing costs. The jumbo mortgage lender may also require at least two assessments of the value of the home before approval.
Read more: 7 Ways To Succeed As A Mortgage Broker
This type of home loan is guaranteed by the Federal Housing Administration (FHA) and issued by a government approved lender.
Designed to help low to moderate income borrowers, FHA loans allow down payments as low as 3.5% if you have a credit score of 580 or higher. You can still qualify if you have a credit score between 579 and 500, but you must make at least a 10% down payment.
Prospective borrowers must also have a debt-to-income ratio (DTI) of 50% or less to gain approval. DTI is the percentage of your before-tax income that you use to pay off student loans, car loans, credit cards, mortgages, and other debts.
Regardless of the down payment amount, the FHA requires borrowers to pay mortgage insurance to protect the lender in the event of default.
6. VA loan
VA mortgages are insured by the US Department of Veteran Affairs (VA). Like conventional mortgages, they can be issued by banks, private lenders and credit unions.
Active military personnel and veterans who meet the required length of service may qualify for a VA loan. Surviving spouses of service members who died in service are also eligible.
Unlike most other mortgages, home purchase loans in Virginia do not require mortgage insurance or down payment. Interest rates also tend to be lower than FHA home loans and fixed rate mortgages.
The program also offers cash refinancing to replace a conventional mortgage with a VA loan. Borrowers can also finance the cost of home improvements.
Remember that VA loans have certain limitations and potential drawbacks for some borrowers. For example, you cannot buy a vacation home or investment property. A licensed VA appraiser must first assess whether the property meets departmental standards.
Finally, the borrower must also pay finance charges to cover foreclosure costs – in the event of default by the mortgagor.
Read more: The best cities for seasoned buyers
7. USDA loan
Backed by the US Department of Agriculture, USDA loans are designed to help low-income applicants purchase homes in rural areas and certain suburbs. The program allows you to obtain loans directly from the USDA or a participating lender with interest rates as low as 1%.
To be eligible, you must have a debt ratio of 41% or less. The USDA will likely consider higher DTIs if your credit score is at least 680.
The USDA also issues home loans to applicants deemed unable to obtain mortgages through traditional channels. These are borrowers who are below the low income limit and without “decent, safe and sanitary housing”.