What Types of Mortgage Loans are Available?
A quick snapshot:
- Conventional Mortgage – fixed rate, most common type of home loan
- Adjustable Rate Loan (ARM) – rate fluctuates, best for short term home ownership
- FHA Home Loans – ideal for first time home buyer, 3.5% down payment
- USDA Loans – very low interest rate, no down payment
- VA Loans – no down payment, no PMI for military veterans
- Jumbo Loans – for higher priced homes
Fixed Rate Loan
In a fixed rate loan, the interest rate that you pay will be fixed for the duration of the loan. This means that even if prevailing interest rates rise or fall, your loan payments will stay the same each month. You will need to put money down with this type of loan, and if your down payment is less than 20% of the purchase price, you will have to carry private mortgage insurance. You will also be responsible for closing costs, unless you have an agreement with the seller that they pay the fees.
Adjustable Rate Loan
The rate of interest on an Adjustable Rate Loan will be adjusted a number of times by the addition of a special margin to an index that is specified by the length of your mortgage. In other words, a one year mortgage of this type will adjust on a yearly basis. The payments you are expected to make will generally rise or fall as the interest on your mortgage adjusts. However, you should be aware that this type of mortgage has limits as to the amount of adjustment that can take place. These limits apply across the entire time of the loan.
Just like the name indicates, the interest rate uses a combination of fixed and adjusting rates. The qualifying standards are often more liberal than traditional loans, and there are options that are designed to meet a wider variety of needs.
Government and Conventional Loans
Home loans are either conventional or government loans, which are the FHA, VA and RHS (or USDA) loans. All other available loans are Conventional.
FHA Home Loan
FHA loans are a type of home loan that is insured, not by a private financial institution, but by the Federal Housing Administration (FHA). This type of loan has become more common over the course of the past decade due to one factor – the FHA loan is friendlier to a first time home buyer than many other types of loans. More about FHA Loans…
VA Home Loan
VA loans are guaranteed by the U.S. Department of Veteran Affairs and are made by private lenders, such as banks, savings & loans, or mortgage companies to eligible veterans for the purchase of a home. The guaranty means the lender is protected against loss if you or a later owner fail to repay the loan.
This type of home loan also has easier eligibility requirements than conventional loans, often lower closing costs, and more liberal terms (usually no down payment is required) including negotiable interest rates. More about VA loans…
RHS (USDA) Home Loan
The RHS or USDA loan program, under the U.S. Department of Agriculture, is another type of home loan that offers easier terms, such as no down payment and low closing costs. This type of loan is made available for rural residents, who have a low-to-moderate income, are without adequate housing, and are unable to obtain credit elsewhere. The can be used for construction or repair of a new or existing home.
Conventional loans are classified as conforming or non-conforming.
A conforming conventional loan is one that adheres to the Fannie Mae (FNMA: Federal National Mortgage Association and Freddie Mac (FHLMC: Federal Home Loan Mortgage Corp.) guidelines. These two corporations purchase, package and sell loans that meet their conditions, as securities to investors. They are referred to as A paper loans, and must meet certain guidelines regarding the loan limits, down payment and borrower qualification such as credit score.
Non-Conforming Loans (Jumbo Loans)
Non-conforming loans are often offered by portfolio lenders to high credit-risk borrowers with a poor credit history. These types of home loans are considered B, C or D loans. Because the lenders don’t plan to sell the loans on, they can be more liberal about the home buyer’s eligibility requirements. Because of this, they typically have a higher interest rate.
Considering Your Options
Because there are so many types of home loans available, a buyer has to consider all their needs before making a loan choice. You must determine how much of a monthly mortgage payment you can afford, as well as how long you plan to stay in your house.
An option other than fixed rate, such as an ARM or hybrid loan, may be your best choice if you are not planning on staying in the home long term. They offer lower interest rates in the earlier stages of the loan, and have the option to convert or phase into a fixed rate over time.
Additional Types of Home Loans
Second Mortgage (or Home Equity Loan)
The standard type of refinance loan is the home equity loan, one that many homeowners employ to get existing equity out of their homes, to be used toward home renovation projects or to raise money for other approved purposes. It is secured by the equity in your property; with both loans considered together, they should not comprise more than 75-80% of the home’s appraised value. A second mortgage tends to have higher interest rates and shorter term, such as 10 or 15 years.
Getting a second mortgage can be a big advantage to a homeowner. They are often used for home improvements, credit consolidation, college funds or other financial needs. The terms are less flexible though, because the lender of a second mortgage is at greater risk, taking second place to the first mortgage.
To obtain a second mortgage, you will have to verify information such as income, have a good credit rating, and you’ll be required to get an appraisal on your home.
Home Equity Line of Credit
A home equity line of credit (HELOC) is similar to a home equity loan, except that the funding can happen over a period of time. An appraisal will be required to determine the amount of the equity-based line of credit. This credit line is an approved sum against which the borrower may draw (or pay down and even draw back up) as desired, up to that pre-determined amount, for a specific duration of time (5, 10, even 20 years).
Most often the interest rate will fluctuate month by month during the funding period. Generally you will make monthly interest-only payments until the loan is completely funded. Once that pre-set funding period is over, the credit line will convert to a second mortgage loan, and payments for both the principle and interest will begin. Many of the loan costs and fees applicable to the first mortgage are required for the HELOC as well.
Carry Back Loan
When a borrower does not have sufficient down payment to qualify for the first mortgage (generally at least 20% down is required), a seller may offer to carry back a second mortgage for the difference. Although the interest rate on the seller’s loan is generally higher than the first mortgage, the carry back loan provides a way for the buyer to finance the portion not included in the first mortgage.
A Two-Step mortgage begins with a fixed rate (usually lower than a fixed rate mortgage would be). There is one adjustment after a certain time (usually 5 or 7 years) to a new fixed rate – set at the current market rate at the time of the change. This adjustment has a cap to ensure that it will never be more than 6 percentage points higher than your original rate.
Much like a two-step mortgage, some ARMs provide an option to later convert to a fixed rate (based on the current market rate, at the time of conversion, but generally a little higher). The option may be easily exercised at certain specified times (generally during the first five years) for a nominal fee.
Contrary to convertible ARMs, fixed-period ARMs begin with a fixed rate that extends for a specified fixed period. At the end of that period, the interest rate (with certain caps) adjusts annually. The interest rates are lower than a standard 30-year mortgage as the lenders risk is lower since they are not locked in so long.
A balloon loan is a short-term fixed-rate loan with low, fixed payments for the short term period, but requiring a single large payoff, due at the end of the term (5, 7 or 10 years.) This can be advantageous if you plan on moving or selling within a few years. Even if you stay beyond the end of the short term of your balloon loan, you may be able to reconsider financing options at that time.
Generally a first mortgage will only finance 80 percent of the value of your property, requiring the borrower to pay a down payment for the difference. If your down payment is short, a piggyback loan serves like a second mortgage to make up the difference. The two loans are approved at the same time.
Zero Down Mortgage
Qualification for a zero down mortgage is based on your ability to make your monthly payments. However, the loan will be larger than a typical mortgage and the interest rates higher. Not all lenders will make zero down mortgages; you may have to shop around. However, FHA loans have extremely small down payment requirements, coming close to a zero down mortgage.
Bridge loans cover the time period between when a buyer closes on a new mortgage and finalizes the sale of his previous home, at which time the bridge loan is paid off. This time period of owning both houses creates several problems for the buyer. Offers made with a contingency clause (contingent on the sale of the current house) are often turned down. Also, the buyer would be obligated on two mortgages, causing financial overburden repercussions.
Bridge loans are usually 1 year loans, structured to pay off the first house, provide for six months interest on the bridge loan and closing costs, and contribute toward the down payment on the new house. The bridge loan is paid off when the first house sells. If the house does not sell within the first six months, the buyer will make interest-only payments on the bridge loan.
A buydown loans is a fixed rate mortgage that allows the borrower to pay points to lower the interest rate. The option may include a reduction for the life of the loan or only for a specified few years at the beginning of the loan. Some options will even finance the discount points. A buydown option lowers the payment amount and opens the possibility of qualifying for a higher priced home.
A reverse mortgage is designed to help elderly home owners benefit from their equity without having to sell their house or make payments. The loan is funded through a lump sum payment, monthly payments or a line-of-credit. The money received from the loan is not taxable nor is it considered in determining Social Security or Medicare benefits. The loan does not have to be paid until the homeowner sells the property, moves or passes away. The elderly home owner is secure in the home even if the loan term ends or the loan grows beyond the value of the property.