The Basics About Mortgage Loans

If you are considering purchasing a home, it is essential to know and understand all of your financing options. There are three main types of mortgage loans that lenders offer; each loan has benefits and drawbacks depending on your individual circumstance. The three main mortgage loans are conventional loans, jumbo loans, and government-insured loans.

  1. Conventional Loan

A conventional loan is the most common type of mortgage loan and is funded by private lenders. When applying for a conventional loan, lenders have strict regulations on your credit score and your debt-to-income ratio (DTI). Borrowers generally need a credit score of at least 620 to qualify for a conventional loan and a DTI of 50 percent. You can put as little as 3 percent down on a home, however, if you put less than 20 percent down, you generally have to pay private mortgage insurance (PMI).

Pros:

  • Interest rates and overall fees tend to be lower than other loans
  • Can put as little as 3 percent down

Cons:

  • Significant documentation is needed for employment verification, assets, and down payment
  • Will need to pay PMI if your down payment is less than 20 percent

Who should get it?

This type of loan is great for borrowers with stable income, strong credit, steady employment, and at least a 3 percent down payment.

  1. Jumbo Loan

A jumbo loan is essentially a conventional loan with a higher loan limit. Most commonly, jumbo loans are required when purchasing a high-value property. For most of the U.S., the loan limit for a jumbo loan is $548,250. However, in certain high-cost areas, the loan limit is $822,375. While the interest rates for jumbo loans are similar to conventional loans, they generally require a higher credit score and lower DTI to qualify. This requires more in-depth documentation.

Pros:

  • Interest rates are similar to conventional loans
  • Can borrow more money for a high-value home

Cons:

  • It is difficult to qualify for; typically need a credit score of 700 or higher, significant assets, and a DTI lower than 45 percent

Who should get it?

A jumbo loan is great for affluent buyers looking to purchase a high-value property. A jumbo loan is determined based on how much financing you need for your home, and buyers who have a good credit score and DTI would benefit from this type of loan.

  1. Government-insured Loan

While the U.S. Government is not a mortgage lender, they do aid some private mortgage lenders to help more people become homeowners. There are three types of government-insured loans:

  • FHA Loans – FHA loans are insured by the Federal Housing Administration. To qualify for this loan, borrowers need a minimum credit score of 580 in order to put as little as 3.5 percent down. You can also qualify with a credit score of 500 if you put at least 10 down. In addition, FHA Loans have two mortgage insurance premiums. One premium is paid in full at closing while the other is paid annually for the life of the loan if you put less than 10 percent down.
  • USDA Loans – USDA loans are insured by the United Stated Department of Agriculture. This type of loan helps low-income families buy homes in rural areas. To qualify, you must purchase a home in a USDA-eligible area and meet specific income limits. In addition, many types of USDA loans do not require a down payment.
  • VA Loans – VA loans are insured by the Department of Veteran Affairs. VA loans allow you to purchase a home with no down payment and offer much lower interest rates. To qualify, you must meet certain service requirements in the Armed Forces or National Guard.

Pros:

  • Interest and required down payment are generally lower and can help save a lot of money
  • Credit score and DTI requirements are more relaxed

Cons:

  • Must meet very specific criteria to qualify
  • There are many insurance premiums which could result in higher borrowing costs

Who should get it?

Government-insured loans are great options for buyers who do not qualify for conventional loans or have minimal cash and a low credit score. If you meet the requirements for Government-insured loans, this is a great option.

In addition to the three main types of mortgage loans, you can choose whether you would like a fixed-rate or an adjustable-rate mortgage for each of the above-mentioned loan types.

  1. Fixed-rate Mortgage

A fixed-rate mortgage is a type of loan in which the interest rate stays the same over the entire term. Common terms for fixed-rate loans include 15 years, 20 years, and 30 years. Having a fixed-rate mortgage ensures that your mortgage payment will stay the same from month to month.

Pros:

  • Will have a consistent mortgage payment throughout the term of the loan
  • This allows for easier budgeting

Cons:

  • It takes longer to build equity on home
  • The longer the loan term, the more interest paid

Who should get it?

Buyers that are purchasing a home they plan to stay in for a long time should consider a fixed-rate mortgage. This is a safe option with more stability for monthly payments.

  1. Adjustable-rate Mortgage

An adjustable-rate mortgage loan (ARM) is a type of loan where the interest rates fluctuate depending on market conditions. This means that your mortgage payment can vary from month to month, either higher or lower. It is common for ARMs to have a fixed interest rate for a few years before the loan changes to a variable interest rate for the rest of the term. The most common loan term for an ARM is 30-years, while common introductory periods with a fixed interest rate are 5, 7, or 10 years. ARMs often include rate caps to stop your interest rate from fluctuating too drastically with the market.

Pros:

  • The introductory fixed rate is generally lower than many other types of loans
  • Can save a lot of money on interest with an ARM

Cons:

  • Monthly mortgage payments can raise significantly, making them difficult to pay

Who should get it?

ARMs are a good option for people purchasing a starter home who plan to move before the fixed-rate introductory period expires. This allows you to take advantage of the below-market interest rates while minimizing risk for the adjustable interest rates in the future.

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Christian’s practice includes litigation, appeals, real estate, government and municipal law, and a full range of business law matters. He is Board Certified in Real Estate Law.
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