When shopping around for the best mortgage, you'll find several programs for first-time and repeat homeownership. The different types of mortgage loans available to you when home buying can depend on factors such as your credit score, desired type of property, income, military affiliation, housing location and preferences for a down payment. For example, you can find several low down payment options with a good credit score, while borrowers with worse credit experience fewer and costlier options for their home purchase.
Use this guide to types of mortgage loans to discover what options you have as well as to differentiate them based on general and credit score requirements and the borrowers they target.
Read More: Buying a Home Programs: What You Need to Know
Introduction to Mortgage Loans
While mortgage loan features vary, this type of financing fulfills the purpose of making payment for a property easier by splitting up the cost into monthly mortgage payments made over a loan term of 10 to 30 years in most cases. The amount of the loan you take out depends on any down payment made, the property's sale price and any fees or other items rolled into the loan. The home is the security for the loan in case the lender needs to foreclose on it. Further, borrowers pay common fees for borrowing, such as interest as well as private mortgage insurance (PMI), a guarantee fee or a similar cost for loan origination.
Some home loans have government backing where a federal government agency insures the amount, and this can lead to benefits such as easier qualifications. Conventional loans, on the other hand, don't have that backing, so they usually have higher standards for borrowers but may allow for higher loan amounts.
Read More: What Is the Meaning of Home Loan?
You'll come across both conforming and non-conforming loans as well. Conforming loans make up most mortgages and come with lower property price limits, while non-conforming loans may have higher amounts or looser qualifications than what the government and other agencies may set.
It's also important to understand how interest rates work for mortgages since the charge largely affects your total borrowing cost. If you have a fixed-rate mortgage, you pay the same fixed interest rate over the life of the loan, while adjustable-rate mortgages are less predictable for mortgage payments and interest rates over time. With either interest rate structure, your rate can depend on many factors, including market conditions, your location, the current federal rates, the mortgage program, your credit score and down payment, and even whether you buy a condo versus a single-family home. Whether fixed or variable, higher interest rates result in higher monthly payments.
Read More: What Is an Adjustable Rate Mortgage?
Learning About Conforming Conventional Mortgage Programs
The very popular conforming conventional loan program allows borrowers to finance homes up to a certain amount based on the cost of living in the county where the property is located. Down payments start at just 3 percent for conventional loans, and the money can be gifted if necessary. Further, special programs through Freddie Mac and Fannie Mae are available to assist first-time homebuyers who may have lower incomes or certain credit challenges. These loans also offer much in terms of flexibility since they're not restricted to a primary residence like with government-backed programs.
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To get these benefits of conventional loans, you must meet strict qualifications from the lender. For example, the minimum credit score is usually 620 with many lenders wanting it to be even higher. Certain programs have income limits, and several months of cash reserves are usually necessary. You also need a back-end debt-to-income (DTI) ratio of 45 to 50 percent at most. Lenders usually also require two years of income stability with documentation backing up those funds.
Annual PMI appears in your mortgage payments or is added upfront for a conventional loan unless you make a 20 percent down payment.
Read More: What Is a 15 Year Conforming Mortgage?
Exploring Federal Housing Administration Loans
Federal Housing Administration (FHA) loans stand out as accessible to a large number of homebuyers who might have credit scores lower than what they need to qualify for other programs. While other options require a 620 or higher credit score, FHA loans set the minimum at lower credit scores of just 500 with a 10 percent down payment. If your score is at least 580, that amount drops to 3.5 percent. For potential borrowers without down payment funds, the FHA allows them to get the money from other sources, such as charities or relatives.
FHA loans work for a variety of existing primary residences as well as new construction. This government-backed option usually requires a 31 percent DTI ratio on the front end and a 43 percent DTI ratio on the back end unless borrowers have a very high credit score or a large amount of money saved. To make it easier to meet income requirements, the FHA allows rental income for people who want to buy multifamily properties. Borrowers pay two mortgage insurance premiums – one upfront and another added to their monthly payments.
Looking at Veterans Affairs Loans
Known as a popular option for potential homebuyers who have limited down payment money saved, U.S. Department of Veterans Affairs (VA) home loans target veterans and current military personnel along with spouses of those who have passed away while on duty. You can find out if you qualify for this loan program by submitting a Certificate of Eligibility application, as the VA has various service requirements that depend on one's military affiliation, service dates and length of service. Some people who have been discharged from the military can qualify, too.
VA loans work for a primary home of various types, and the borrower can either buy one or build one. Along with not having a down payment required for most homebuyers, this borrowing option offers some flexibility for income and DTI ratios. For example, the maximum DTI ratio is usually set at 41 percent but can be higher for a borrower who just got discharged from the military, has a lot of cash saved or has a high income that can offset existing debt payments. Lenders often want a credit score of 620 or higher on par with conventional mortgages, and an initial funding fee applies.
Considering U.S. Department of Agriculture Mortgages
Of the loan programs available, the U.S. Department of Agriculture (USDA) single-family housing loan option stands out since it's intended only for homebuyers who make under a certain income and who wish to buy or build a primary residence in a rural area. A USDA loan limits borrowers to 115 percent of the median household income set in the county of the property. Further, borrowers need to consult the USDA's property eligibility maps to make sure the home's address qualifies.
Like a VA loan, a USDA loan provides the benefit of allowing borrowers to get a home without down payment funds or significant cash reserves. However, this program can have stricter standards than VA, FHA and even conventional loans. For example, the minimum credit score from the lender usually starts at 640, and the DTI ratios top out at a conservative 29 percent on the front end and 41 percent on the back end. Borrowers will experience an upfront USDA guarantee fee and then another fee added to each monthly mortgage payment.
Read More: What Is a USDA Home Loan?
Researching Non-Conforming Jumbo Mortgages
Jumbo mortgages fall into the category of non-conforming loans since they involve the lender providing the borrower with a loan amount over the typical loan limits that can vary significantly by locale. For example, according to the current conforming loan limits, someone buying a single-family home in Los Angeles would need a jumbo loan to borrow more than $822,375. On the other hand, a person buying the same kind of property in Atlanta would need a jumbo loan to borrow more than $548,250.
By loaning borrowers such a large amount of money, lenders face more risk and thus are more selective in approving applicants for jumbo mortgages. Depending on the property price, a minimum down payment can range from 10 to 40 percent, while your credit score should be close to 700 to qualify. Lenders will want to see a large amount of cash reserves (up to 18 months) and a low DTI ratio closer to 40 percent for these loans. Borrowers can expect to pay more interest as well to make up for the risk.
Read More: What Is a Jumbo Mortgage?
Looking at Other Non-Conforming Loans
Underwriters will check borrowers' qualifications against the guidelines for the specific mortgage program and lender, and people who have trouble getting a home loan through the options listed so far might look into a type of non-conforming loans called non-qualified mortgages as an alternative. These mortgage loans are popular with borrowers such as real estate investors, self-employed individuals and aspiring homeowners who struggle with credit requirements or income stability. Usually, fees and higher interest rates apply to offset the higher risk lenders take on.
Lenders who offer these loans usually provide flexibility for such borrowers as well as alternate ways to prove they can afford the mortgage payment. For example, they might let someone without a regular job get a mortgage if they have a large amount of money in the bank or plan to rent the property out for money. They might also let borrowers with unstable income use bank statements rather than pay stubs to verify the money. People who want to borrow a large loan amount might qualify with a smaller down payment than a regular jumbo loan would require.
Exploring Seller-Financed Home Loans
Sometimes available when a seller wants to get rid of a home quickly by avoiding the lengthy traditional mortgage closing process, seller financing can provide a short-term loan to a borrower who may not otherwise qualify for financing elsewhere. The seller would work out a loan with terms the buyer agrees to, and they'd come up with a mortgage payment that might be based on a typical 30-year term. However, the agreement usually says the buyer will only make payments for a much shorter time and then give the seller a balloon payment, which they might do by eventually taking out a mortgage with a lender.
There are various possible arrangements, and the seller can set requirements regarding factors like credit and DTI ratio. For example, a seller might provide full or partial financing, but they could also do a lease-to-own arrangement or land contract. A higher down payment may be needed for seller financing to reduce the risk to the seller, and interest rates can be negotiated.
Read More: What Is Home Finance by Owner?
Choosing the Right Home Loan
Now that you understand the types of mortgage loans and the requirements, you can get an idea of which options might fit your needs. You might find it helpful to obtain your credit score through one of the bureaus or a credit reporting website to narrow down the programs for which you most likely qualify. You can also consider your cash reserves when deciding which program has a down payment requirement you can meet. Also, keep in mind that you probably need be a considerable amount of cash for closing costs, too.
To better determine which mortgage loans fit your situation, search for one or more lenders who can make an assessment based on your information, and then weigh the pros and cons of different mortgage programs. You may find prequalification and pre-approval tools on lenders' websites to simply learn of an approval amount based on your income, credit score, debts and estimated home price. From there, you might call or meet with lenders to discuss moving forward, learn about special homebuyer assistance programs or do a comparison to get the best rate loan available.
- Griffin Funding: Non-QM Mortgage Products
- NOLO: Seller Financing: How It Works in Home Sales
- Consumer Financial Protection Bureau: What Is a Jumbo Loan?
- Lending Tree: Minimum Mortgage Requirements for 2021
- FHFA: Fannie Mae and Freddie Mac Maximum Loan Limits for Mortgages Acquired in Calendar Year 2021 and Originated after 10/1/2011 or before 7/1/2007
- Credible: Jumbo Loans: Requirements, Limits, and Rates
- U.S. Department of Agriculture: Single Family Housing Guaranteed Loan Program
- U.S. Department of Veterans Affairs: VA Home Loans
- U.S. Department of Veterans Affairs: Eligibility Requirements for VA Home Loan Programs
- U.S. Department of Housing and Urban Development: Let FHA Loans Help You
- Consumer Financial Protection Bureau: Conventional Loans
- Federal Trade Commission: Shopping for a Mortgage
- Consumer Financial Protection Bureau: Understand Loan Options
- Consumer Financial Protection Bureau: How Does Paying Down a Mortgage Work?
- Quicken Loans: FHA Loans – Purchase and Refinance Loan Requirements for 2021
Ashley Donohoe has written about business and technology topics since 2010. Having a Master of Business Administration degree, bookkeeping certification and experience running a small business and doing tax returns, she is knowledgeable about the tax issues individuals and businesses face. Other places featuring her business writing include Zacks, JobHero, LoveToKnow, Bizfluent, Chron and Study.com.