Different Types of Mortgages
When you apply for a mortgage loan, especially if it is your first time, one of most common questions you might ask is what type of mortgage should you get. There are countless loan programs available that seemingly they are tailored for all types of mortgage needs. So, having a general understanding of most common mortgage types will help you to choose your mortgage loan wisely.
Conventional loans versus Government-backed loans
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Conventional loans are the most common loan type of mortgage. These loans are sponsored by government enterprises, Fannie Mae and Freddie Mac. Borrowers can take an advantage of this loan type if they have a large down payment of typically 20% or more, decent credit score of 620, and Debt-to-Income (DTI) ratio of 50% or less. Conventional loans tend to offer low interest rates and fees. They do offer with less down payment as little as 3% - 5%, you will need to purchase a mortgage insurance policy.
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Government-backed loans are insured by government agencies, and those loans are well-known as FHA (Federal Housing Administration), VA (Veteran Affairs), and USDA (United States Department of Agriculture). The main scope of these three agencies is to protect mortgage lenders if the borrower become unable to repay the loan. These types of mortgages are offered to borrower who has low credit score as low as 500 (FHA), or who has served in our military with $0 down payment (VA), or who is purchasing a property in an eligible suburban or rural area (USDA).
Conforming loans versus jumbo loans
The main difference between conforming loans and jumbo loans is the loan amount limit. The conforming loan limit in most of parts of the country is $726,200.00, any loan amount above this limit is considered as a jumbo loan. These two loan types have a lot in common, except jumbo loans require:
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higher credit scores.
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more money for a down payment.
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cash reserves after your loan funded.
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a low Debt-to-Income (DTI) ratio.
Besides these two types of mortgage loans, there are a few other types that are not commonly used, such as renovation loans, construction loans, reverse mortgages, portfolio loans, etc.
Fixed Rates versus
Adjustable-Rate Mortgages (ARMs)
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Fixed-rate mortgages have an interest rate and monthly payment that are set throughout the duration of the loan. It gives a peace of mind and helps you to budget easier. A fixed-rate mortgage might be a better choice if you have an idea that you will be living in or keeping the property for a long period of time. However, it does have a disadvantage that if rates drop, your fixed rate will not automatically drop unless you refinance your loan.
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Adjustable-Rate Mortgage (ARMs) have an introductory period of fixed interest rate typically the first 5, 7, or 10 years. After the introductory period ends, the interest rate most likely changes according to the agreement and depending on how market rates move. ARMs can be quite confusing because they consist of several terms that determine the outcome of each rate change, such as how often and how high the rate can change each year, and what is the rate cap throughout the life of the loan. For instance, if you have a 5/1 ARM with 1/2/5 caps and an initial interest rate of 4.0%, it means this mortgage has an interest rate of 4.0% during the first 5 years. After that, the rate will change once a year with maximum of 1% each time and no more than 2% per year. Lastly, throughout this loan, the cap rate cannot be more than 9%. Since ARMs normally have low interest rates during the introductory period, they might be a good option if you know you will not keep the property for a long period of time. It also helps to get your loan approved easier if your loan application is on the fence of high DTI, because its payment is lower than the one on a fixed-rate mortgage. However, ARMs could be risky loans if you will possess the property longer than the introductory period and the market rates hike, that means your monthly mortgage payment will increase.
