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 must 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.
The best type of mortgage for you will primarily be determined by whether 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 interest 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, 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 for the first seven years and followed by yearly adjustments. Adjustable-interest rate mortgages are generally considered to be riskier 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 it is secured by the government. This doesn’t mean that it’s impossible to get a loan above the conforming limit. It just means 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.
- Fannie Mae – financial products and services that make it possible for low to middle income families to buy a home of their own
- Freddie Mac – organization working to stabilize mortgage markets and expand home ownership opportunities
- USDA Rural Home Loan Program Eligibility requirements for the USDA home loan program.
- Veterans Home Loan Program Learn how the VA Home Loan helps service members obtain homeownership
- HUD Rehabilitation Loan 203K HUD Rehabilitation Loan for first-time homebuyers