As a prospective home buyer, it’s just as important to research types of mortgages as it I to look into the neighborhoods you want to live in. It can be overwhelming to determine which mortgage provides the best value, is within your reach and serves your long-term homeownership needs. Below is a summary of different types of mortgages to help you with your homeownership journey.
CONVENTIONAL MORTGAGE
A conventional loan is not backed by the federal government. Borrowers with good credit, stable employment and income histories, and the ability to make a 3% down payment can usually qualify for a conventional loan backed by Fannie Mae or Freddie Mac.
Private mortgage insurance (PMI) is usually required on a conventional loan if you can’t make at least a 20% down payment. Private mortgage insurance is an additional insurance policy to protect your lender if you cannot repay your mortgage. You’re typically required to pay PMI monthly, up front or a combination of the two if you haven’t saved at least 20% toward the price of the home you’re buying with a conventional loan.
Conventional loans have higher minimum credit score requirements than other loan types, typically 620, and are harder to qualify for than government-backed mortgages. The most common type of conventional mortgage is a conforming loan. It adheres to Fannie Mae and Freddie Mac guidelines and has loan limits, which often change annually to adjust for increases in home values.
Ideal for: Borrowers with a steady income and employment history, strong credit and at least a 3% down payment.
GOVERNMENT- INSURED FEDERAL HOUSING ADMINISTRATION (FHA) LOAN
The Federal Housing Administration (FHA) backs these types of mortgage loans, which cater to borrowers with credit blemishes and limited down payment funds. Low- to moderate-income buyers purchasing a house for the first time typically turn to loans insured by the FHA when they can’t qualify for a conventional loan. Borrowers can put down as little as 3.5% of the home’s purchase price.
FHA loans have more relaxed credit score requirements than conventional loans. However, the FHA doesn’t directly lend money; it guarantees loans by FHA-approved lenders. You can qualify for an FHA loan with a 580 credit score and a minimum 3.5% down payment. If your score is between 500 and 579, you’ll need a 10% down payment.
FHA loans have mandatory mortgage insurance premiums. If you put down less than 10%, you’ll pay FHA mortgage insurance for the life of your loan — unless you refinance into a conventional loan after building at least 20% equity.
GOVERNMENT-INSURED VETERANS AFFAIRS (VA) LOANS
The U.S. Department of Veterans Affairs (VA) guarantees homebuyer loans for qualified military service members, veterans, and surviving spouses. Borrowers can finance 100% of the loan amount with no required down payment. VA loans are made by private lenders, like mortgage companies and banks, and not the Department of Veterans Affairs. Other benefits include fewer closing costs (which may be paid by the seller), better interest rates, and no need for PMI or MIP.
VA loans charge a funding fee, which is a percentage of the loan amount that helps offset the cost to taxpayers. The funding fee varies depending on your military service category and loan amount.
The following service members do not have to pay the funding fee:
• Veterans receiving VA benefits for a service-related disability
• Veterans who would be entitled to VA compensation for a service-related disability if they didn’t receive retirement or active duty pay
• Surviving spouses of veterans who died in service or from a service-related disability
• A service member with a proposed or memorandum rating stating eligibility for compensation due to a pre-discharge claim
• A service member who received the Purple Heart
VA home loans offer competitive interest rates and terms and can be used to purchase a singlefamily home, condominium, multi-unit property, manufactured house or new construction.
GOVERNMENT-INSURED U.S. DEPARTMENT OF AGRICULTURE (USDA) LOANS
The U.S. Department of Agriculture (USDA) insures USDA loans provided to low- and moderateincome buyers looking to purchase homes in designated rural areas. No down payment or mortgage insurance is required for these types of home loans, but there are income limitations. USDA loans are best for homebuyers in eligible rural areas with lower household incomes, little money saved for a down payment, and who can’t otherwise qualify for a conventional loan product.
SECOND MORTGAGES/HELOC
Second mortgages are a different type of mortgage loans that allows you to borrow against the equity you’ve built in your home over time. Similar to a first mortgage, which is the loan you use to buy a home, a second mortgage is secured by your home. However, a second mortgage takes a subordinate position to a first mortgage, which means it’s repaid after a first mortgage in a foreclosure sale.
A Home Equity Line of Credit (HELOC) is a revolving credit line with a variable rate that works similarly to a credit card. The funds can be used, repaid and reused as long as access to the credit line is open.
Both home equity loans and home equity lines of credit (HELOCs) are types of second mortgages.
REVERSE MORTGAGES
Homeowners age 62 and older may qualify for a reverse mortgage, a mortgage loan type that differs from a traditional “forward” home loan. Instead of you making payments to your lender, your reverse mortgage lender makes payments to you — from your available equity — in a lump sum or monthly.
The home equity conversion mortgage (HECM) is the most common type of reverse mortgage. It’s insured by the FHA and comes with several upfront and ongoing costs. HECMs, like FHA loans, also have loan limits. You have many options for repaying a reverse mortgage, including selling your home or refinancing to take out a new, forward mortgage to cover what’s owed.
Key features:
• Don’t require payments until the home is sold or the borrower (or eligible surviving nonborrowing spouse) moves out or dies
• Require borrowers to have at least 50% equity in their home
• Require borrowers (or surviving spouses) to continue to maintain the home, live in it as a primary residence and pay property taxes and homeowners insurance
CONSTRUCTION LOANS
A construction loan is a short-term loan that covers only the costs of custom home building. This is different from a mortgage, and it’s considered specialty financing. Once the home is built, the prospective occupant must apply for a mortgage to pay for the completed home.
You can use a construction loan to cover the total cost of building a home, including the land, labor, materials and permits. The approval process for a construction loan is similar to that of a typical mortgage in that you’ll need to apply and submit documentation to your lender.
Once approved, you’ll be able to start accessing the funds in conjunction with each phase of construction. An appraiser or inspector will check in on the build throughout the construction process so that the borrower can continue to have access to funds.
After the home’s construction is complete, you’ll be issued a certificate of occupancy. Then, your construction loan will likely be converted to a traditional mortgage, and you’ll begin to make payments on the principal and interest.
There are several types of Construction Loans:
• Construction-Only Loan: This type of loan is short-term and meant to cover only the actual construction period.
• Construction-To-Permanent Loan: Construction-to-permanent loans are a financing option for prospective custom home builders. Like construction-only, construction-to-permanent financing are one-time loans that fund construction and then convert into a permanent mortgage. During the construction phase, borrowers make interest-only payments.
• Renovation Loan: Renovation loans, also known as FHA 203(k) loans, can be used for home renovation and are insured by the Federal Housing Administration (FHA). This allows borrowers to both purchase and renovate their new home while still making one monthly payment to cover both costs. Conventional loan borrowers may qualify for these loans through Fannie Mae (HomeStyle Renovation) and Freddie Mac (CHOICE Renovation). Other options include a home equity loan or a home equity line of credit (HELOC). No matter what you want to change about your home, there are plenty of options to get the financing you need to start swinging that sledgehammer. Rocket Mortgage has Home Equity Loan options.
• Owner-Builder Loan: Usually when you build a home, there’s a general contractor who essentially acts as head of the whole operation. However, some prospective home builders wish to act as their own general contractor, and some banks offer owner-builder loans just for this purpose. These types of loans generally require the borrower to demonstrate through experience, education and licensing that they have the needed expertise to oversee the home’s construction.
Conclusion
It’s important to get the type of mortgage loan that fits your financial situation.
