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05.20.24

Types of Mortgages

Not all mortgages are the same, and it’s important to understand the benefits of each type before purchasing a home. There are five main types of mortgages available to homebuyers. To help you find the best home loan for your needs, we’ve listed them with some pros and cons for each one.

Conventional Loans – Traditional & Lowest Cost

No bells, whistles or fine print here. A conventional mortgage is a standard loan that isn’t backed by the Federal Housing Administration (FHA). It’s the most straightforward loan that gives you the money you need to buy a house. It’s paid back over the life of the loan, usually over 15, 20 or 30 years. These loans come in two subtypes – conforming and non-conforming loans.

Conventional loans may require you to purchase private mortgage insurance (PMI). It’s basically an insurance policy that covers your lender in the event you can’t pay back what you borrowed. PMI can increase the overall cost of your loan, but conventional loans usually require less borrowing and lower closing costs than other types – even if the interest rate is slightly higher. You can avoid PMI if you're able to put at least 20% down on your home.

Pros:

  • Simple, straightforward terms
  • Available from the majority of lenders
  • Lower closing costs
  • Rewards good credit with good rates

Cons:

  • Need a credit score of at least 620 to qualify
  • Interest rate may be higher than that of other loans
  • Requires higher down payment than other loans
  • Requires PMI if down payment is less than 20%

As a prospective homebuyer, you can choose between an adjustable-rate mortgage (ARM) and a fixed-rate mortgage. So, what’s the difference?

An ARM is a home loan with an interest rate that adjusts over time based on the market. ARMs typically have a lower initial interest rate than fixed-rate mortgages, making them an attractive option if your goal is to get the lowest possible mortgage rate starting out.

This interest rate won’t last forever, though. After the initial period, your monthly payment can fluctuate periodically. If interest rates go down, ARMs can become less expensive. However, ARMs can also become more expensive if rates go up.

A fixed-rate mortgage offers more certainty because it retains the same interest rate for the life of the loan. That means your monthly principal and interest payment will stay constant throughout the loan term. If you’re planning to stay in your home for a long time and are looking for a more stable monthly payment, this could be the right loan option for you. If interest rates decrease, you could even consider refinancing to get a lower rate.

Government-Insured Loans – FHA, VA, USDA

The U.S. government isn’t a mortgage lender, but it does play a key role in making homeownership accessible to more Americans. If you need a mortgage but can’t qualify for a conventional loan because your credit score isn’t high enough, a government-backed loan may be best for you. With these types of loans, the Federal Housing Administration (FHA) promises to pay back your lender if you default on your loan. This allows them to loosen some of the credit requirements so those with a lower score can qualify. There are three types of government-backed loans – FHA, VA and USDA.

FHA Loans

Insured by the Federal Housing Administration (FHA) and can be offered at as low as a 3.5% down payment. FHA requires a mortgage insurance premium (MIP) if your down payment is less than 20%. This helps ensure lenders in the unfortunate event that you default on your loan. The ceiling for how much you can borrow is often lower with these loans.

VA Loans

Guaranteed by the U.S. Department of Veterans Affairs (VA) and are for eligible members of the U.S. military (active duty, veterans, National Guard and Reservists) as well as their surviving spouses. There’s no mortgage insurance or minimum down payment, but you’ll need to pay a funding fee ranging from 1.25% to 3.3% at closing.

USDA Loans

Guaranteed by the U.S. Department of Agriculture (USDA) and available to low-to-moderate income borrowers within certain income limits buying a home in rural, USDA-eligible areas. A major benefit to this type of loan is eligible borrowers can finance with a 0% down payment. Guarantee fees do apply.

Government-insured loans are best for those who meet the requirements and have lower credit scores or require smaller down payments.

Pros:

  • Much more flexible credit and down payment guidelines

  • Helps borrowers who otherwise wouldn’t qualify for a conventional loan

Cons:

  • Might require MIP

  • Can have higher closing costs and fees

Jumbo Loans – Bigger Mortgage, High-End Home

Jumbo mortgages are typically borrowed for larger, more expensive properties. A jumbo mortgage surpasses the Federal Housing Finance Agency’s (FHFA) conforming loan limits, or the amount the FHA has determined that traditional loans cannot exceed. Because home values vary across the United States, the maximum limit depends heavily on where you live. The 2024 conforming loan limit is over $700,000 but could be much higher in areas with a high cost of living.

If you need a jumbo loan, you’ll have to prove that you can assume most of the risk and are a safe bet for your lender, since your jumbo loan won’t be insured by traditional policies. Your bank will require extensive documentation to prove you have enough savings in the bank and a steady income. You’ll also need a high credit score of about 700 to get the most competitive rates and a down payment of at least 10 to 20 percent.

Pros:

  • Can finance a more expensive loan

  • Competitive interest rates

  • Takes high-cost-of-living areas into consideration

Cons:

  • Requires a high credit score

  • Not available with every lender

  • Requires a higher down payment

Construction Loans - Finance The Building of a Residential Home

Are you building a new home and need financing for construction? A construction loan may be right for you. The money loaned is often advanced incrementally during the building phase of the home. While some construction loans can roll over into standard mortgages when building is complete, most of the time interest is only paid during the construction period and the loan will come due when the building phase is over.

Funding new build projects tends to be riskier than buying an existing home, so construction loans often carry higher interest rates and can be more difficult to get than regular home mortgages. Still there are many lenders who can help home builders obtain these types of loans.

The two most popular types of construction loans are construction-to-permanent loans and stand-alone loans. A construction-to-permanent loan converts into a permanent mortgage when the building is completed, and a stand-alone construction loan only covers the construction time frame. Stand-alone construction loans typically have a one-year maximum term, so they may call for a smaller down payment.

Pros:

  • Loan is based on the project or future home value, not available equity

  • Shorter repayment terms

  • Lower long-term interest costs

Cons:

  • Loan amount set in advance

  • Little flexibility on loan terms

  • Higher interest rates than a secured loan

Finding the right mortgage that works for you can seem like a daunting task, but it doesn’t have to be. Your lender will provide you with all the information to help you choose your mortgage type.

If you don’t already have a lender, we’re here to help. Atlantic Union Bank has a team of dedicated and knowledgeable Mortgage Loan Officers ready to help you find the right product for your needs. For information on mortgage options, visit AtlanticUnionBank.com/Mortgage or fill out a brief questionnaire to meet with one of our mortgage professionals.

 

Sources: Bankrate, Banzai, Investopedia

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