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Before venturing into homebuying, you might think a mortgage is just a mortgage—you go to the bank, they decide whether to offer you a loan, and once you're approved, you begin making payments. But you'll soon find out there are many types of mortgage loans offered by lenders, each with its own borrowing criteria, restrictions, benefits and drawbacks.
To determine which type of mortgage loan is best for you, you'll need to consider your credit score, how much you can put toward a down payment, how large of a loan you need, and how quickly you want to pay it off, among other factors.
Is a Conventional Loan Right for Me?
A conventional loan is the most common type of mortgage, and the one that usually comes to mind when you think of a home loan. They're offered by just about every mortgage lender. Unlike FHA or VA loans, conventional loans are not government-backed.
What to Consider When Getting a Conventional Mortgage
Conventional loans are ideal for borrowers who have a stable income and documented employment history. Typically you can't qualify for a conventional loan with a credit score below 620. Lenders also look at your debt-to-income ratio (DTI), and if more than 36% of your monthly income goes toward debt payments, you might not be approved.
Conventional loans onced required a 20% down payment, but many lenders now allow less if the borrower has great credit and solid income. Technically, the down payment can be as low as 3% on a conventional loan, but if you don't put down at least 20%, you'll have to pay private mortgage insurance (PMI) until your mortgage balance is 80% or less of the home's value. You might also end up with a higher interest rate if you make a low down payment. Paying monthly PMI and a higher interest rate will increase the overall cost of your mortgage, so you need to weigh whether this is worth going in with a lower down payment.
Is a Government-Insured Mortgage the Right Choice?
A few types of government-backed loans have more lenient borrowing criteria than conventional loans. The main ones you'll see are FHA, USDA and VA loans.
FHA loans are backed by the Federal Housing Administration, and their purpose is to help first-time homebuyers who might not be able to qualify for a conventional loan. Borrowing criteria is more lax, with lower credit score and income requirements. The down payment can be as low as 3.5%, but unlike with a conventional mortgage, you may have to pay mortgage insurance for the life of the loan. Interest rates on FHA loans are often a bit higher than that of conventional loans since the borrowing standards are less stringent.
The U.S. Department of Agriculture offers mortgage loans to low- and middle-income homebuyers in eligible rural areas. The USDA has a direct lending program only for low-income Americans, with extremely low interest rates and no required down payment. It also offers a guarantee program in which it backs loans granted by local lenders (similar to a VA or FHA loan). These loans allow a zero down payment and offer low rates, but you might have to pay mortgage insurance.
Backed by the U.S. Department of Veteran Affairs, a VA loan is a home loan specifically for former and current military service members and eligible family members. These mortgage loans permit a zero down payment with no private mortgage insurance, and interest rates are typically lower than with conventional loans. To qualify, you must provide proof of stable income that shows you can repay the loan, and you must obtain a Certificate of Eligibility from the VA.
What to Consider When Getting a Government-Insured Mortgage
If you're unable to qualify for a conventional loan, or your priority is getting a loan with as low a down payment as possible, government-insured loans can be a great option. They're ideal for eligible borrowers with low cash savings.
Government-insured loans are also a good option for homebuyers with bad credit. An FHA loan permits credit scores of 580 and above with a down payment of 3.5%, and it sometimes will allow credit scores as low as 500 with a down payment of 10% or more. While VA loans don't have an official credit score minimum, most lenders require a score of around 620. USDA loans typically require a score of 640 or above, and you can't earn more than a certain amount (based on your location).
Keep in mind that not all lenders offer government-backed loans. You'll need to research local and online lenders to findes that do offer these loans and compare rates before deciding on one.
When Is a Jumbo Mortgage the Right Option?
Conventional loans are also sometimes referred to as conforming loans, which means they "conform" to government limits that are intended to keep the housing market stable. Loans that exceed this amount are called noncoforming loans, or jumbo loans, but what qualifies as a jumbo loan can vary widely depending on location. That's because in hot markets in places like San Francisco, the average house costs a lot more than it does in areas like the Midwest. In most regions, however, a jumbo loan is anything over $484,350.
What to Consider Before Getting a Jumbo Mortgage
Because a jumbo loan is by definition a large mortgage loan for an expensive home, it is really only for borrowers who have high incomes and can comfortably make the large loan payments.
Borrowing criteria for jumbo mortgages is usually stricter than for conventional loans. You typically need a FICO® Score* of at least 700, and most lenders want to see six to 12 months' worth of payments saved in your bank accounts. Jumbo loan borrowers often need to put down as much as 15% to 30% to secure the loan.
Should I Get a Fixed-Rate Loan or Adjustable-Rate Mortgage?
Mortgage interest rates come in two flavors: fixed-rate and adjustable-rate. Fixed-rate mortgages have one interest rate and payment amount for the entire life of the loan.
Adjustable-rate mortgages (ARMs), on the other hand, have an introductory period in which the interest rate remains the same and is often lower than a fixed-rate annual percentage rate (APR). But after a predetermined time period, it becomes variable. For example, with a 5/1 ARM, the interest rate would be fixed for the first five years, then adjust each year after. The rate adjusts according to market conditions, so it could go up or down. There are caps on how high it can go, but it can make your monthly payment unpredictable.
Here's an easy way to figure out which type of interest rate is best for you. If you're going to stay in your home long term, a fixed-rate mortgage is usually better since it provides predictability for decades. However, if you plan to stay in the home for only a few years, an ARM could save you money if you move out before the adjustment period hits, since the initial rate is usually lower than a typical fixed-rate mortgage.
Should I Choose a 30-Year or 15-Year Mortgage?
Mortgages typically provide you with several different term options, but the two most common you'll encounter are 30 years and 15 years. There are a few important things to know when choosing your term.
First, the shorter your term, the higher your monthly payment will be because you have less time to pay off the loan. One big plus, though, is it also means you'll pay less interest over the life of the loan since you're knocking out the debt faster—sometimes tens of thousands of dollars less. Also, interest rates are lower on shorter-term loans.
When deciding on your mortgage term, think about how much you can afford to pay each month. If you have a high, stable income and plentiful savings, you might feel confident going with a 15-year term. But if your income is lower or inconsistent, or you just want the lowest mortgage payment possible, a 30-year term might be best. Keep in mind that you can usually make extra mortgage payments or pay extra in principal on each payment, so you could err on the side of caution and get a longer term, but overpay when you're able. That will help you pay off the loan faster and spend less on interest payments over the life of the mortgage.
Check Your Credit Score
As you start exploring your mortgage loan options, knowing your credit score can help you quickly figure out which loans make the most sense for you. You can check your Experian credit score for free to get the process started.