A new home may be one of the biggest purchases you’ll make in your life. Before you begin shopping for the right home to buy, you’ll need to explore mortgage options if you’re planning to finance the purchase.
Not all home loans are the same, though. So, doing your research before moving forward can help you select the most suitable option for your financial situation and possibly keep more money in your pocket. Plus, you’ll know what to expect, in terms of guidelines, when you apply.
Types of mortgages
Conventional loan – Best for borrowers with a good credit score
Jumbo loan – Best for borrowers with excellent credit looking to buy an expensive home
Government-insured loan – Best for borrowers who have lower credit scores and minimal cash for a down payment
Fixed-rate mortgage – Best for borrowers who’d prefer a predictable, set monthly payment for the duration of the loan
Adjustable-rate mortgage – Best for borrowers who aren’t planning to stay in the home for an extended period, would prefer lower payments in the short-term and are comfortable with possibly having to pay more in the future
1. Conventional loan
Conventional loans, which are not backed by the federal government, come in two forms: conforming and non-conforming.
Conforming loans – As the name implies, a conforming loan “conforms” to the set of standards put in place by the Federal Housing Finance Agency (FHFA), which includes credit, debt and loan size.
Non-conforming loans – These loans do not meet FHFA standards. Instead, they cater to borrowers looking to purchase more-expensive homes or individuals with unusual credit profiles
Pros of conventional loans
Can be used for a primary home, second home or investment property
Overall borrowing costs tend to be lower than other types of mortgages, even if interest rates are slightly higher
Can ask your lender to cancel private mortgage insurance (PMI) once you’ve reached 20 percent equity, or refinance to remove it
Can pay as little as 3 percent down on loans backed by Fannie Mae or Freddie Mac
Sellers can contribute to closing costs
Cons of conventional loans
Minimum FICO score of 620 or higher is often required (the same applies for refinancing)
Higher down payment than some government loans
Must have a debt-to-income (DTI) ratio of no more than 43 percent (50 percent in some instances)
Likely need to pay PMI if your down payment is less than 20 percent of the sales price
Significant documentation required to verify income, assets, down payment and employment
Who should get a conventional loan?
If you have a strong credit score and can afford to make a sizable down payment, a conventional mortgage is probably your best pick. The 30-year, fixed-rate conventional mortgage is the most popular choice for homebuyers.
2. Jumbo loan
Jumbo mortgages are home loan products that fall outside FHFA borrowing limits. Jumbo loans are more common in higher-cost areas such as Los Angeles, San Francisco, New York City and the state of Hawaii, where home prices are often on the higher end.
Pros of jumbo loans
Can borrow more money to purchase a more expensive home
Interest rates on jumbo loans tend to be competitive with other conventional loans
This may be the only way for some borrowers to gain homeownership in areas with extremely high home values
Cons of jumbo loans
Down payment of at least 10 percent to 20 percent required in many cases
A FICO score of 700 or higher usually required
Cannot have a DTI ratio above 45 percent
Must show you have significant assets in cash or savings accounts
Usually require more in-depth documentation to qualify
Who should get a jumbo loan?
If you’re looking to finance a home with a selling price exceeding the latest conforming loan limits a jumbo loan is likely your best route.
3. Government-insured loan
The U.S. government isn’t a mortgage lender, but it does play a role in making homeownership accessible to more Americans. Three government agencies back mortgages: the Federal Housing Administration (FHA), the U.S. Department of Agriculture (USDA) and the U.S. Department of Veterans Affairs (VA).
FHA loans – Backed by the FHA, these home loans come with competitive interest rates, and help make homeownership possible for borrowers without a large down payment or pristine credit. You’ll need a minimum FICO score of 580 to get the FHA maximum of 96.5 percent financing with a 3.5 percent down payment. However, a score as low as 500 is allowed if you put at least 10 percent down. FHA loans require two mortgage insurance premiums, which can increase the overall cost of your mortgage. Lastly, with an FHA loan, the home seller is allowed to contribute to closing costs.
USDA loans – USDA loans help moderate- to low-income borrowers who meet certain income limits buy homes in rural, USDA-eligible areas. Some USDA loans do not require a down payment for eligible borrowers. There are extra fees, though, including an upfront fee of 1 percent of the loan amount (which can typically be financed with the loan) and an annual fee.
VA loans – VA loans provide flexible, low-interest mortgages for members of the U.S. military (active duty and veterans) and their families. There’s no minimum down payment, mortgage insurance or credit score requirement, and closing costs are generally capped and may be paid by the seller. VA loans charge a funding fee, a percentage of the loan amount, which can be paid upfront at closing or rolled into the cost of the loan along with other closing costs.
Pros of government-insured loans
Help you finance a home when you don’t qualify for a conventional loan
Credit requirements more relaxed
Don’t need a large down payment
Available to repeat and first-time buyers
No mortgage insurance and no down payment required for VA loans
Cons of government-insured loans
Mandatory mortgage insurance premiums on FHA loans that cannot be canceled unless refinancing into a conventional mortgage
Loan limits on FHA loans are lower than conventional mortgages in most areas, limiting potential inventory to choose from
Borrower must live in the property (although you may be able to finance a multi-unit building and rent out other units)
Could have higher overall borrowing costs
Expect to provide more documentation, depending on the loan type, to prove eligibility
Who should get a government-insured loan?
Are you having trouble qualifying for a conventional loan due to a lower credit score or minimal cash reserves for a down payment?FHA-backed and USDA-backed loans could be a viable option. For military service members, veterans and eligible spouses, VA-backed loans are often better than a conventional loan.
4. Fixed-rate mortgage
Fixed-rate mortgages maintain the same interest rate over the life of your loan, which means your monthly mortgage payment always stays the same. Fixed loans typically come in terms of 15 years or 30 years, although some lenders allow borrowers to pick any term between eight and 30 years.
