A quick overview of your mortgage loan options

Mature realtor showing couple interior of house and explaining mortgage options Image: Mature realtor showing couple interior of house and explaining mortgage options

In a Nutshell

The galaxy of mortgage loan types may seem intimidating at first, but Credit Karma can help break down your options and narrow your choices when it comes time to pick one.

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At first glance, the various types of mortgage loans may look like a mysterious alphabet soup.

There are FHA loans, HARP loans, ARMs and other hard-to-remember acronyms. But when you actually break down the most common loan types, it’s easier to understand which ones might be a good fit for your financing needs. That’s a good thing, because whether you’re buying your first home or want to refinance your mortgage, you’ll be a savvier, more confident shopper if you know all your options.

You may also benefit from a consultation with a lender who can match your individual needs with the right loan program. “Anyone who wants to finance a home purchase or refinance should talk to a mortgage lender who understands the value of education,” says Darryl Crawford, regional manager of Sente Mortgage in Austin, Texas.

But even before you meet with a lender, you can begin the education process by reviewing the following common loans. We’ve broken them down into three categories depending on the type of loan:

  • Basic loan types: The most common types of loans you’ll encounter. As these are not insured or guaranteed by a government agency, they’re generally considered a higher risk for lenders, so credit and income requirements may be stricter.
  • Government-insured loans: These loans are federally insured to protect the lender if you fail to repay the loan. The FHA (Federal Housing Administration) and VA (Department of Veterans Affairs) are among the various government agencies that insure or guarantee these loans.
  • Loan repayment options: There are different repayment options for your loan, including fixed-rate mortgages and adjustable-rate mortgages, or ARMs.

Basic loan types

Conventional loans

A conventional loan is any loan that’s not insured or guaranteed by a government agency. Conventional loans tend to feature lower interest rates than government-insured loans such as FHA loans or VA loans.

Most conventional loans require a down payment of at least 5 percent, but Bill Banfield, executive vice president of capital markets for Quicken Loans in Detroit, says this isn’t a hard-and-fast rule. “We have a conventional loan with 1 percent down and a 3 percent grant for borrowers who make less than the area median income for their county,” he explains.

With that said, you’ll ideally want to plan for at least a 20 percent percent down payment. Borrowers who make a down payment of less than 20 percent generally must pay private mortgage insurance (PMI) on conventional loans, but that insurance will fall off once your home equity reaches 78 percent, according to Banfield.

Conventional loans are generally a good choice for borrowers with good to excellent credit, since they typically cost less than some government programs.

Conforming loans

As its name implies, a conforming loan is a conventional loan that “conforms” to a set of loan limits established by Federal Housing Finance Agency for mortgages acquired by Fannie Mae and Freddie Mac, which are “government-sponsored enterprises” that were placed under the federal government’s control after the housing crisis. Conforming loans for one-unit properties are limited to $424,100 in 2017 in most areas of the country, but that limit is higher in certain housing markets.

Crawford says the guidelines borrowers must meet for a conforming loan include the borrower’s loan-to-value ratio, debt-to-income ratio, credit score and credit history, etc. To calculate your debt-to-income ratio, divide all your monthly debt payments by your gross monthly income.

Interest rates for conforming loans depend on a variety of factors, including your credit and the size of your down payment.

Nonconforming loans

Nonconforming loans include all loans that don’t match the loan limits and other requirements of conforming loans, explains Crawford.

Many non-conforming loans are jumbo loans (see below), but some lenders also approve loans for borrowers with large investment accounts in their financial institution.

Jumbo loans

A jumbo loan is a loan for an amount that exceeds the conforming loan limits for the county where the property is located. Because it doesn’t “conform” to the loan limit, a jumbo loan is by definition nonconforming.
According to Banfield, down payment requirements differ depending on the case and the lender, but you may need a higher credit score to be approved for a jumbo loan, due to the higher risk the lender is taking on. You also need to have sufficient income to afford the higher payments on a larger loan.

Government-insured loans

FHA loans

FHA loans, which are federally insured by the Federal Housing Administration, require a down payment as low as 3.5 percent and tend to have looser guidelines.

These loans may be a good option for borrowers with less cash and a lower credit score. Of course, lenders may have their own standards that require a higher credit score.

“FHA loans require upfront mortgage insurance and annual mortgage insurance that you generally pay monthly over the course of the term” says Crawford, “so it’s wise to compare your options with a conventional loan to see which is a better fit.”

VA loans

A VA loan is any home loan made by private lenders and guaranteed by the U.S. Department of Veterans Affairs (VA). “VA loans are a benefit to veterans and offer a great option because they don’t require a down payment [as long as the sales price doesn’t exceed the appraised value] or mortgage insurance,” says Banfield.

Veterans and active members of the military should check their eligibility before applying for such a loan.

USDA loans

Government-insured U.S. Department of Agriculture (USDA) loans do not require a down payment and may have lower mortgage insurance premiums. USDA loans require borrowers to meet certain household income limits for the area where they want to buy a home, says Banfield.

The house must also be located in an eligible rural area, but Banfield notes that you might be surprised about what qualifies as “rural.” “Areas that are in the outer suburbs may qualify for this program,” he says.

HARP loans

The Home Affordable Refinance Program (HARP) allows certain homeowners who have a conventional mortgage backed by Fannie Mae or Freddie Mac to refinance, even if they owe more on their mortgage than the value of their home.

The Federal Housing Finance Agency has extended the application date for HARP until Sept. 30, 2017, and eventually it will be replaced by a similar refinance program.

Loan repayment options

Fixed-rate loans

A fixed-rate loan locks in your interest rate for the entire loan term, which typically ranges from 10 to 30 years.

“Most first-time buyers choose a 30-year fixed-rate loan because they like the long-term predictability,” explains Crawford. Interest rates are typically lower on shorter loan terms, but the payments are higher because of the shorter repayment period.

Adjustable-rate mortgages (ARMs)

Adjustable-rate mortgages have an interest rate that may go up or down. Typically, the interest rate under an ARM will stay the same for five, seven or 10 years and then adjust annually after that.

“The rates are lower initially, so they appeal to people who know they will move or who believe they are on a career path that will make future payments affordable even if they rise,” says Banfield.

ARMs are often popular for refinancing, particularly for borrowers planning to sell their home or fully pay off their loan in the near future.

Bottom line

To figure out which loan is right for you, you may have to think hard about your overall financial goals, your budget and your assets.

If you’re still a little confused, that’s fine – the vast array of mortgage options can make anyone’s head spin after a while. Consider contacting a lender to discuss which loan could be the best fit for your individual needs.