Different Types of Mortgages
Most people do not have the funds to purchase real estate out of pocket which means they'll have to obtain a mortgage. However, there are various types of mortgages available and the type of mortgage you should choose will depend upon your specific situation and goals.
One of the most common types of home loans is a conventional mortgage, which is a home loan that the federal government does not insure. Those looking to obtain a conventional loan will have to choose between two different types: conforming and non-conforming.
A mortgage is considered to be a conforming loan when the mortgage amount is within the maximum limits set by Freddie Mac or Fannie Mae, which are federal government agencies tasked with backing most mortgages in the U.S.
Mortgages, however, which do not fall within the limits set by the Federal Housing Finance Agency (FHFA) are known as non-conforming loans, otherwise referred to as jumbo loans. Due to the higher risk faced by the lender, borrowers looking for a non-conforming loan are usually required to make larger down payments as well as have a top-notch credit history. Additionally, non-conforming loans generally charge higher interest rates.
Government-insured Home Loans
Owning a home is considered a part of the American dream. This is why the U.S. government works actively to assist Americans in purchasing homes. There are three federal agencies in charge of insuring mortgages: U.S. Department of Agriculture (USDA), Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA).
FHA loans are designed for those who do not have enough money for a large down payment. Also, FHA loans are easier to obtain for those without the best credit history. A borrower will need to have a FICO score of at least 580 to qualify for a 3.5% down payment. However, those with lower credit scores, can qualify for a 10% down payment mortgage as long as they have, at least, a 500 FICO score.
VA loans are provided exclusively to U.S. military members and their families. These types of loans are known for their flexibility and low interest rates. Another great thing about VA loans is that no down payment is required. VA loans usually limit the costs associated with closing a real estate transaction. Despite the many benefits, the VA charges a funding fee for VA loans based upon a percentage of the mortgage amount in order to help offset costs to taxpayers for the program.
USDA loans are designed to help people purchase a home in designated rural areas. However, specific income limits must be met to qualify for a USDA loan. In some cases, those with low incomes can obtain a USDA loan without having to make a down payment.
A home loan with a fixed rate maintains the same interest rate throughout the lifetime of the loan. This means the monthly home loan payments always remain the same. Fixed-rate mortgages are generally for 15, 20 or 30 years. Fixed-rate mortgages are useful because they enable you to more easily plan your monthly finances. On the other hand, you usually end up paying more interest charges with a longer-term mortgage with a fixed rate. Also, it usually takes longer to build home equity for those with a fixed-rate mortgage.
Although it seems like a fixed-rate loan is usually preferable due to its stability, this may not always be the best option for some people. Those who do not plan to stay for more than a few years in their home, may want to opt for an adjustable-rate mortgage (ARM). An ARM has a fluctuating interest rate which can increase or decrease according to market conditions. However, many ARMs offer a fixed rate for a specified number of years before the mortgage changes to a fluctuating interest rate for the rest of the term. Therefore, those planning on selling their home after a short period of time can lock in a low interest rate and save significantly on interest payments.
On the other hand, ARMs do come with their own set of risks. It is possible that market conditions change dramatically, which could result in a large spike in interest rates and therefore higher monthly mortgage payments. Those who are not prepared for such fluctuations in monthly costs, could be forced to default on their mortgages. Also, home values could fall after a couple of years, making it challenging to sell your home or to refinance before the mortgage resets to a fluctuating interest rate.
A Mortgage Should Fit Your Specific Situation
Choosing the correct type of mortgage will require close examination of your own personal financial situation and goals. Those who are more affluent, may have different goals compared to those with more moderate- or low-income levels. Credit history may limit some people's choices, while other factors, such as military service, may offer additional benefits.