What Types of Mortgages Are There — And Which Is Best for You?

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Before shopping for a mortgage, you'll probably want to think about which kind of home loan you want. You'll likely have a choice between a few different types of mortgages, designed for people in different situations. 

For example, someone who's just starting to build credit and is buying their first home is going to have different needs from someone who's upgrading to a new summer cottage.

Once you’ve got a handle on the basics of mortgages and home loans, read on to learn about the main types of home loans and see which one might be right for you.

Conventional loans

A conventional loan is any mortgage that isn't offered through a government program. Most home loans are conventional.

Conventional mortgages can be a bit more flexible than other types of loans because they don't have to follow any particular program's rules for eligibility. But that doesn't mean anything goes! Lenders decide who they're willing to offer conventional loans to, so you'll need to meet their requirements. Plus, if you want a kind of conventional loan known as a conforming loan, there are some additional criteria that apply.

Conforming loans

Conforming loans follow guidelines that allow them to be bought by Fannie Mae or Freddie Mac, the companies that were created by the government to help make mortgages more affordable and accessible. When Fannie Mae and Freddie Mac purchase loans from lenders, the lenders' risk goes down and they may be willing to offer longer loans at better rates.

If you take out a conforming loan, you can be confident that your loan has features that are standard in the mortgage industry and that you've gone through a rigorous process to qualify.

The details of conforming loans

The government sets the conforming loan limits every year, and a conforming loan can't be larger than the limit for the county where the home is located. Places where housing costs are high have higher limits.

You may qualify if you have a credit score of at least 620 and if the amount you would spend on debt payments each month — including mortgage payments and payments on other loans — isn't higher than 45% to 50% of your monthly income, with the higher cap applying to people who have great credit or a lot of savings. 

You might be able to make a down payment as low as 3%, but anything less than 20% is going to mean you have to pay for private mortgage insurance. This insurance protects the lender in case you don't make payments, and it adds to the cost of the loan.

Conforming loans often have lower interest rates than non-conforming loans or FHA loans.

Who is this type of loan best for?

If you have a decent credit score and money for a big down payment, a conforming loan may be your best option — although you'll probably want to check if you qualify for a USDA loan or a VA loan before making a decision.

How to get started

To apply for a conforming loan, you'll need to contact some private lenders. You'll be asked for your Social Security number, annual income, the address of the home you'd like to buy, how much the home is worth, and your desired loan amount to get the ball rolling. 

It's a good idea to locate documents like bank statements, pay stubs, and your income tax returns so you have them ready when it's time to submit them.

If you want, you can look up the conforming loan limit for a property's location to check if the amount you plan to borrow is under the limit. 

Non-conforming loans

Any conventional loan that doesn't meet the requirements for a conforming loan is a non-conforming loan. Sometimes, a mortgage is simply too big to be a conforming loan. In that case, it's called a jumbo loan.

But some mortgages are non-conforming because the borrower has too much debt or poor credit, or because the features of the loan are irregular — like if the borrower is allowed to pay only interest for a while. These loans are often more expensive and might be harder to pay off.

The details of non-conforming loans

To qualify for a jumbo loan, you can expect that you'll need a credit score of at least 680, although requirements will vary by lender. Your monthly debt payments generally shouldn't be higher than 43% of your monthly income, and you'll probably be asked to make a down payment of at least 20%. Don't be surprised if you're quoted higher interest rates than the rates on conforming loans, because lenders have to compensate for the higher risk of lending a large amount.

If you're looking for a non-conforming loan that isn't a jumbo loan, be aware that you're heading into a space that's a bit like the Wild West of mortgage lending. You might get approved despite having a low credit score, shaky proof of income, or a level of debt that wouldn't fly with other lenders. But you're missing out on some safeguards that protect borrowers with conforming loans and you'll probably be charged a high interest rate.

Who is this type of loan best for?

If you have excellent credit and you're shopping for an expensive property, getting a jumbo loan to finance your large purchase might make sense.

You also might want a non-conforming loan if there's something special about your situation that disqualifies you from a conforming loan, but you're confident that you can make mortgage payments. For example, maybe you have a lot of debt because you just graduated from medical school or law school, but you've embarked on a profitable career and you have strong earning potential. In that case, a non-conforming loan might be the best way forward if you don't want to postpone homeownership.

How to get started

Just like with conforming loans, you'll have to contact private lenders to start an application. If you're interested in a non-conforming loan because there's something unusual about the property you want to buy or your finances, be prepared to explain the situation to lenders.

FHA loans

FHA loans are offered by private lenders but backed by the Federal Housing Administration. This program allows lenders to offer mortgages to some borrowers who might not otherwise qualify for an affordable loan, either because they can't put much money down or because they don't have great credit. Oftentimes, FHA loans go to people who are new to homeownership.

The details of FHA loans

Lenders can set their own criteria for FHA loan applicants, but there are some rules that apply across the board. The loan amount can't be larger than a set limit, which varies depending on where the property is located. And the property has to pass an inspection certifying that it meets safety standards and is likely to stay in good shape for years to come.

You'll need a credit score of at least 500 to get an FHA loan, but if your score is less than 580, you'll be asked to make a down payment of 10%. You'll also need to show that you have a steady source of income. And in most cases, your mortgage payment plus your other debt payments can't be more than 43% of your monthly income.

You might be allowed to make a down payment as low as 3.5% on an FHA loan with a credit score of 580 or higher, but the flip side is that you have to make a payment for mortgage insurance when you take out the loan and then pay annual insurance premiums. And the interest rates on FHA loans tend to be higher than on conventional loans.

Who is this type of loan best for?

If your credit score is low and you don't have enough savings to make a down payment of at least 10%, there's a good chance you'll get better terms on an FHA loan than on a conventional mortgage. But it's smart to check your eligibility for a USDA loan or a VA loan, too, because those options might be more affordable.

How to get started

You can find a list of lenders who are approved to offer FHA loans on the Department of Housing and Urban Development's website. Lenders can help you figure out if you're a good candidate for an FHA loan and walk you through the application process. Or, you can contact a housing counseling agency to learn more about the FHA eligibility criteria and explore whether this type of mortgage is right for you.

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USDA loans

USDA loans are meant for borrowers who are buying a home in a rural area and who don't have high income. The USDA guarantees mortgages that are offered by private lenders, and it also has a different program lending money to homebuyers directly.

The details of USDA loans

To qualify for a USDA-backed loan, you can't have income above 115% of the median. If you work for an employer, you'll need to show your income history for one year. But if you're self-employed or doing seasonal work, you'll be asked for two years of income records.

There's no credit score requirement. In fact, it's okay if you don't even have a traditional credit score as long as you can show other proof of meeting financial obligations, such as paying rent and utilities on time.

Your debt payments including the mortgage payment can't make up more than 41% of your monthly income. And you'll need to show that you can't get a conventional loan without being charged private mortgage insurance. 

If you can clear those hurdles, you might qualify for a low-interest loan with no down payment. There is an annual fee, though.

USDA direct loans are for people with low income who don't have another way to get safe housing. You'll have to share information about your income, assets, and debts to find out if you qualify and how much you're eligible to borrow.

Properties financed with these loans have to be small in size and can't have a value above a limit that's set for their location.

USDA direct loans usually don't require a down payment, and you don't have to pay mortgage insurance. You can get up to 33 years to pay back the loan, and you might even qualify for a 38-year loan term if your income is very low. These loans have a fixed interest rate that can work out to as little as 1% when you factor in the USDA's payment assistance program. Just keep in mind that if you sell your home before paying off the mortgage, you might be required to pay back all or part of that payment subsidy.

Who is this type of loan best for?

A USDA loan can be a great choice if your income is low to moderate and you're buying a house in a rural area.

How to get started

To find out if a home's address is in an eligible rural area, search the USDA's map. The USDA also offers self-assessment tools you can work through online to see if you might be eligible for a guaranteed loan or a direct loan. After you enter some information about a property's location, the number of people in your household, and your income from different sources, you'll find out whether you're likely to qualify.

Next, you can contact lenders from the USDA's list to apply for a guaranteed loan, or reach out to your state's Rural Development office to get started on a direct loan application.

VA loans

The U.S. Department of Veterans Affairs guarantees loans offered by private lenders. Veterans and members of the military who are eligible for this benefit can typically save money on interest and closing costs by choosing a VA loan over a conventional loan.

The VA also offers direct loans to veterans who are Native Americans or whose spouses are Native Americans.

The details of VA loans

VA guaranteed loans don't usually require a down payment, although if you want to borrow more than the conforming loan limit for the county, you'll have to put some money down. Another major advantage of this type of loan is that you don't have to pay mortgage insurance premiums.

You'll typically get better interest rates on a VA loan than you would on a conventional loan, and closing costs are low. However, you may owe a fee called the VA funding fee unless you qualify for an exemption. The funding fee equals 2.3% of the loan if it's your first time using this benefit and you're making a down payment of less than 5%. So for example, if you're borrowing $200,000 with a down payment of less than $10,000, the fee would work out to $4,600. You can either pay this fee when you close on the mortgage, or you can roll it into your loan and pay it off gradually.

If you're eligible for a Native American Direct Loan, you also won't have to pay mortgage insurance, you can borrow up to the conforming loan limit without making a down payment, and your closing costs should be affordable. Under this program, the interest rate for a 30-year fixed mortgage can be as low as 2.75%.

Who is this type of loan best for?

A VA loan is often the most affordable mortgage option for members of the military, veterans, and eligible surviving spouses.

How to get started

The first step in getting a VA loan is to apply for a Certificate of Eligibility, which shows lenders  you qualify for this type of loan. You can fill out an application through your eBenefits account with the VA, or send in an application through the mail. If you're currently serving in the military, you'll need to provide your date of birth, Social Security number, the name of your command, and the date you entered service. If you're a veteran, you'll need a copy of your discharge or separation papers, and if you're a surviving spouse, you'll need your spouse's discharge papers.

Once you have the Certificate of Eligibility, you can apply for a loan through a private lender or, if you qualify, you can apply for a Native American Direct Loan from the VA. Your VA regional loan center can direct you to approved lenders or offer guidance on applying for a direct loan.

After reviewing the different types of mortgages, you might find that one jumps out at you as a good fit for your situation — but it's okay if that doesn't happen and you're still not sure which to choose. You might want to apply for preapproval for a few kinds of loans to see how the rates and terms you're offered compare. It's often easier to narrow down your options when you've got some concrete numbers in front of you.

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