6 types of mortgage loans: Which one is best for me?

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

In a Nutshell

Whether you’re a first-time homebuyer or a seasoned house flipper, you might come across multiple types of mortgage loans as you consider buying a home. Understanding the six most common types of home loans, and what options they may offer you, may be very useful as you negotiate your way through one of your more complex purchases.
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When you’re looking to buy a home, you have financing options.

Mortgages come in all shapes and sizes. While the 30-year fixed-rate mortgage might be the most traditional, it’s far from the only choice you have. Your lenders will ask you questions about your income, credit and the type of home you’d like to buy. And they’ll use that information to recommend types of loans that would work best for you.

We’ll go over six of the most common types of mortgage loans on the market and discuss a few other important considerations — like what loan term you need and whether a fixed or adjustable interest rate makes more sense for your loan. Let’s dive in.

Conventional loans

If you have good credit and a stable income, chances are your lender will first see if you qualify for a conventional loan. Considered a basic mortgage loan, a conventional loan simply refers to a mortgage that comes from a private lender like a bank and isn’t backed or insured by a government program. Conventional loans can be “conforming,” the most common loan type, or “nonconforming.”

The difference mostly comes down to the size of the mortgage you’re trying to get. Conforming loans have maximum amounts set by the government — $510,000 in most counties (in 2020) — and are designed to be sold to Fannie Mae and Freddie Mac. These government-sponsored entities set other rules and guidelines for the mortgages, including a minimum credit score of 620 in most cases and a minimum down payment of 3% for some qualified borrowers.

Nonconforming loans include jumbo mortgages (which we’ll discuss later), as well as loans that don’t fall into another mortgage category. These can be designed for people with poor credit or wealthy individuals with unusual financial circumstances.

Best for

Conventional loans are best for people with good credit who are looking for what are typically the lowest interest rates and a less complicated application process. These loans tend to cost less than most other types of home loans, like Federal Housing Administration loans — so long as you qualify.

Things to watch out for

If you have less-than-stellar credit, you might have trouble qualifying for a conventional loan. Also be aware that if you put down less than 20%, you’ll usually need to buy private mortgage insurance, which will add to your total loan cost.

FHA loans

If you’re concerned you may not qualify for a conventional loan, an FHA loan could be an option.

Because FHA loans are mortgages made by private lenders but insured by the Federal Housing Administration, the government guarantee may help you qualify for a mortgage you may not have been able to get otherwise.

But it’s important to know that not all applicants will be approved, and you might be required to make a 10% down payment if your credit score is between 500 and 579. With credit scores of 580 or higher, you might be able to make a down payment as low as 3.5%.

While FHA loans may seem attractive, it’s important that you consider the total cost of the loan when comparing it to other options (more on that below). So, while the qualifications are more flexible, when you tally up all the costs involved, including mandatory mortgage insurance for example, FHA loans tend to be a more expensive product over the life of the loan than conventional mortgages.

Best for

FHA loans can be a great option if you can afford a monthly mortgage payment but don’t have the credit score to quality for a traditional mortgage. They also may allow you to buy a home with a low down payment, if you qualify.

Things to watch out for

FHA loans can be more expensive than other types of home loans because the cost of the federal government’s guarantee is passed on to you. The FHA requires you to pay for mortgage insurance on all loans through its program. This is paid in two ways — an upfront payment made as part of the closing costs and a monthly insurance premium.

The upfront mortgage premium is 1.75% of the loan amount ($3,500 for a mortgage of $200,000, for example). The monthly premium is typically 0.85% of the loan per year, or $1,700 annually for a mortgage of $200,000. Unlike with conventional loans, you’ll have to go through a complicated process to cancel mortgage insurance on an FHA loan.

VA loans

If you’re a veteran or actively serving in the military, you’ll likely want to take advantage of a VA loan, if you qualify. VA loans are mortgages insured by the U.S. Department of Veterans Affairs that help service members, veterans and eligible family members buy homes. You’ll take out these mortgages through a private lender, with the federal government guaranteeing a portion of the loan.

Even with the government guarantee, you’ll still need to meet your lender’s credit and income standards to qualify for a VA loan. There’s no set minimum credit requirement, but lenders will take a thorough look at your finances to make sure you can pay back your mortgage.

Best for

If you qualify for a VA loan, they can be a great deal. In many cases, you won’t need to make any down payment at all. The VA guarantee also offers lower interest rates and better terms than you may be able to get elsewhere, especially if you have bad credit. Another plus: VA loans don’t require mortgage insurance premiums.

Things to watch out for

In order to get a VA loan, you’ll need to apply for what’s known as a “certificate of eligibility,” which provides details on your military service history. To qualify, you must have served for a certain length of time, ranging from 90 days to two years depending on when you were in the military. 

USDA loans

If you’re buying a house in a rural area, you may want to consider a USDA loan. USDA loans refer to programs offered by the U.S. Department of Agriculture that help low- and middle-income people afford to buy homes in rural areas. These programs either lend you money directly or guarantee loans made by private lenders, depending on which you might qualify for.

You can use the direct loan program if you don’t currently have adequate housing or can’t afford traditional loans. You typically qualify only if you live in an area populated by fewer than 35,000 people. Additionally, these loans have fixed rates and don’t usually require a down payment. You’ll apply for these directly with a USDA Rural Development office.

The loan guarantee program is much more common. You’ll get these USDA loans through an approved private lender. To be eligible, you generally must make no more than 115% of your area’s median income and live in a rural area. You can search to see if your address is in a qualified area on the USDA website. You won’t have to make a down payment if you qualify.

Best for

As we mentioned, USDA loans are best for people with low and moderate incomes who live in rural areas.

Things to watch out for

You might not qualify. While there are no minimum credit score requirements, you must also be able to prove you can repay the loan. Your total monthly home payment shouldn’t exceed 29% of your monthly income.

Jumbo loans

If you’re buying an expensive home, you’ll likely need to consider a jumbo loan. A jumbo loan refers to a mortgage that’s larger than the Freddie Mac and Fannie Mae conforming loan limits ($510,400 in most areas; higher in high-cost areas). A jumbo mortgage typically goes up to $1 million to $2 million.

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Best for

Jumbo loans are best for people who need a mortgage for a significantly larger amount than the average U.S. home price or the typical home price in their area.

Things to watch out for

To get a jumbo loan, you’ll typically need to have solid credit and be able to make a sizable down payment. Keep in mind that your costs on a jumbo loan can be higher than for a typical mortgage.

Reverse mortgages

If you’re 62 or older and need some cash, you might consider a reverse mortgage. A reverse mortgage is a type of home equity loan designed for seniors looking to tap the value of their home for additional retirement income.

With a reverse mortgage, the lender pays you — either in a lump sum of cash or monthly payments. Typically you’ll owe the balance when you move out of the house, or your spouse or estate will have to repay the loan if you pass away.

The amount you’ll be able to borrow in a reverse mortgage depends on …

  • How old you are
  • The value of your home
  • Market interest rates
  • Your ability to pay for taxes and other household expenses

Best for

Reverse mortgages work best for those who are 62 or older and need funds to help pay for healthcare or other regular expenses.

Things to watch out for

With a reverse mortgage, the amount you owe actually goes up over time as interest and fees are added to the principal. This often means that you, your spouse or heirs will have to sell the home to repay the loan once you move out of the house (or if you pass away).

Other considerations: Variable vs. fixed rate loans

This is a key question you’ll need to consider regardless of the loan type you pick. Most of the loan options above are available either as fixed-rate or variable-rate loans.

If you choose a fixed-rate mortgage, your interest rate is set when you take out the loan and won’t change when interest rates go up or down. This means your monthly payments will stay steady for the life of the loan.

With a variable-rate loan, also known as an adjustable-rate mortgage, your interest rate may go up or down depending on market conditions. Adjustable-rate mortgages typically start with a lower interest rate than a fixed-rate loan but will change after a certain number of years. If interest rates go up, so will your monthly payment.

How to choose? Fixed-rate loans are lower risk over the term of the loan and offer more certainty, even though the initial interest rate tends to be higher. Variable-rate loans can be a good option for people who know they’ll be moving before the introductory period of their loan ends. Historically, about 75% of home buyers choose a fixed-rate loan, according to the Consumer Financial Protection Bureau.

What else should I think about before I take out a mortgage?

You’ll need to consider more than just your loan type when you’re shopping for a mortgage.

Your loan term is an important factor as well. Loans typically range from 15- to 20- and 30-year terms — but other lengths may be available depending on your lender.

Keep in mind that shorter-term loans tend to have higher monthly payments (depending on your down payment), but you can save thousands in interest over the life of the loan. Another consideration is that interest rates on shorter-term loans may be lower.

Depending on your situation, you may also consider a specialty loan like a construction loan or home renovation loan. Construction loans are generally short-term loans used to finance the building of a new house, or renovating an existing one, then convert to a traditional mortgage once the build phase is complete. A home renovation loan, like Fannie Mae’s HomeStyle® Renovation Mortgage, allows you to borrow enough money to buy a home and fix it up before you move in.

Next steps

Once you have a good idea of the type of mortgage that works for you, be sure to take your time shopping around. Learn about all the costs that are associated with a mortgage, especially closing costs, fees and discount points, which you can buy to lower your interest rate.

Here are some other steps to take before you apply for a mortgage.

  • Contact multiple lenders to explore their loan options and costs.
  • Gather the paperwork you’ll need to apply for a mortgage, especially bank statements and pay stubs.
  • Get a preapproval letter from a lender, which lets you know how much home you can afford.

Mortgage rates where you live

Mortgage or refinance rates depend on different factors, including where you live. To better understand what rates you may qualify for, including what the average mortgage or refinance rate is in your area, take a look at Credit Karma’s marketplaces for mortgage rates and mortgage refinance rates.

About the author: Andrew Dunn is a veteran journalist with more than a decade of experience as a reporter and editor at North Carolina news organizations, including the Charlotte Observer and the StarNews in Wilmington. In those roles,… Read more.