Learn about the 6 different types of home loans and which one is best to help you in buying your home. This guide will help you understand the basics of home loans!
When it comes time to buy a home, home buyers have many different options. And I know it can get overwhelming, especially if you’re buying a home for the first or second time.
Now, before we get into it, there are a TON of different types of loans and programs you can get. But we’re not going to get into ALL of those today. I just want to talk about the 6 basic types of home loans.
One of these types of loans will be used a majority of the time by home buyers.
A large majority of home loans use conventional mortgages. A conventional mortgage is a loan that is not backed by a specific government agency (unlike FHA, VA, USDA) and conforms to the requirements set by Fannie Fae and Freddie Mac.
Typically, borrowers will put 20% down. However, you can go as low as 3% down in some instances, but will have to pay PMI (private mortgage insurance) which is an additional expense.
PMI is insurance for the benefit of the lender. Because you are putting less than 20% down on a home, the lender is taking steps to protect itself in case of a default as they are taking on additional risk.
PMI ranges from .5% to 2.5% of the loan amount, depending on your credit score, them down payment amount and the size of the loan. It is typically included as part of your monthly payment.
You typically need a credit score of 620 or higher to qualify for a conventional mortgage. How to Increase Your Credit Score Fast!
- Low down payment options available;
- No PMI when 20% is put down;
- Can use to purchase primary residence, vacation home or rental property.
- Higher credit score required for approval;
- DTI (debt-to-income ratio) typically can’t be above 43% for approval.
An FHA loan is a loan backed by the Federal Housing Administration (FHA). These loans are best for best for buyers that have lower credit scores and less to put down on a home (FHA offers 3.5% down).
Because the loans are backed by the FHA, lenders are protected in case of default by the borrower (you).
You need a credit score of 580 or higher to qualify for an FHA loan. However, you can still qualify with lower scores, you will just need put more down.
FHA rate guide connects consumers with multiple different lenders to find one that meets their needs. Just fill out a simple application, and you will be connected with multiple lenders who customize loans based on the consumer profile!
In addition, the property you are buying must meet some stricter appraisal requirements than a conventional mortgage. It must be in livable conditional and meet certain health and safety standards.
FHA 203(k) Loan
FHA also offers the ability to include up to $35,000 into the price of their mortgage for repairs and improvements on the property. There are certain requirements that need to be met for this that I won’t get into here as it’s beyond the scope of this post.
- Low down payment requirements;
- Lower credit score limits;
- May accept a higher DTI (debt to income) ratio than conventional mortgages.
- Required to pay Mortgage Insurance Premiums (MIP) for the life of the loan;
- Loan limits depending on area and median price;
- Can only use an FHA loan to purchase your primary residence.
Adjustable Rate Mortgage (ARM)
An adjustable rate mortgage is a loan where the interest rates adjusts over time, typically along with changes in market interest rates.
There is usually a fixed portion of the mortgage, for instance, a 5/1 ARM means the rate is fixed for the first 5 years (which means your payment is the same), then adjusts annually depending on interest rates.
This type of mortgage is riskier as your payments could increase substantially if the interest rates increase. However, it offers benefits in that the initial fixed period typically has a lower interest rate than a 30-year fixed mortgage (where your payment stays the same for 30 years).
The most common ARM offerings are 3/1, 5/1, 7/1, and 10/1. However, your lender may have other options as well.
This type of loan can make sense if you know you’re going to move before the fixed period ends AND you can weather payment increases in case things don’t go as planned and you can’t sell your home.
Because this happens. Ask 2008/2009.
- Lower interest rate available for the fixed term.
- After the fixed period is over, payments can increase significantly;
- If your home value drops, you may not be able to refinance or sell your home.
VA (Veteran’s Affairs) Loan
A VA loan is backed by the Department of Veteran’s Affairs. It is typically a 0% down loan with no PMI.
However, there are very strict requirements to getting a VA loan. For one, you need to be a veteran or active duty service member with 90 consecutive days of active service during wartime or 181 days of active service during peacetime.
You can also get a VA loan if you have served for the National Guard for more than 6 years, or you are the spouse of a service member who died in the line of duty.
The VA does not have a minimum required credit score; however, lenders will still look for credit scores of 620 or above. How to Increase Your Credit Score Fast!
- There are options for those with low/bad credit;
- No down payment Is required;
- No mortgage insurance premiums.
- Must meet certain requirements (i.e. be a veteran) to be eligible for the loan;
- There is a mandatory funding fee.
USDA (US Department of Agriculture) Loan
A USDA loan is a loan backed by the US Department of Agriculture. It is a 0% down, low interest loan available to moderate/low income earners in rural areas.
If the area you are buying in qualifies for “rural” designation, this loan is a great option for those who thought they could never own a home.
A minimum credit score of 640 is typically required, although lenders will work with this for a larger down payment.
It is a fixed loan and does require you to pay mortgage insurance, but the fees are substantially lower than that of other loans.
- No down payment required;
- No cash reserves required;
- Low interest rate.
- Only applies to homes in a rural area (not all houses are eligible);
- Can only be used for your primary residence;
- Must pay a loan fee (typically 2% of loan that can be rolled into the purchase price).
A jumbo loan is use when a property is too expensive for conventional financing. This type of loan is seen a lot in expensive cities in California and New York (as well as other areas).
What is considered a “jumbo” loan is different for every county. The average is around $510K, but is higher in high cost areas like San Francisco. For instance, I live in San Diego, and you are required to get a jumbo loan for loans over $701,500 (as of June 5, 2020).
You will typically need a credit score of 700+ to qualify for a jumbo loan, and will be more likely to be approved if you have adequate cash reserves.
Many lenders will also require a down payment of 20% for a jumbo loan, which can be a lot of money out of pocket (how to save for a down payment). In addition, interest rates are usually higher as the lender takes on additional risk.
- Allows you to buy a home in a high cost of living area.
- Higher credit scores (700-720+) may be required;
- Higher down payments may be required (10-20%);
- Interest rate may be slightly higher.
Most home loans will fall into one of the categories above. However, there are many other types of loans as well so be sure to talk to your lender to find out what is best for you.
Have you bought a house recently or are you planning to? Leave a comment below and let me know what type of loan you plan on using. And don’t forget to read these Tips for First Time Home Buyers (it applies to everyone, not just first timers!).