Which Type of Home Loan is Right For You?

If you’re like most millennials, you probably hope to own your own home one day. Imagine it now: Walls painted any shade you want, enough cupboard space for your growing mug collection, and your li’l fur baby won’t have to pay pet rent anymore. 

Your own home is a dream come true – but getting there can be a lengthy and complicated process. Knowing your mortgage options and industry lingo can help you stay calm and cool along the way.

What is a Home Loan (a.k.a., Mortgage)?

A home loan, also known as a mortgage, is a special type of loan you can use to purchase real estate. That could include houses, apartment buildings, commercial buildings, vacant lots and more. If you want to eventually purchase a home of your own, you’ll likely need a mortgage loan.

And although reports from the National Association of Realtors show that 2022 is a tough year for homebuyers, the overall process of mortgage approval to home purchase can be long. It’s important to do your research, know what you can afford and get your ducks in a row early to ensure you’re on the right track when the time comes. 

With that in mind, here are some quick facts you should know about mortgages:

If you’re ready to find a home of your own, the first step is to explore the mortgage options available to you based on your finances, work background and future goals.

Fannie Mae and Freddie Mac

There are two federally backed home mortgage companies created by the U.S. congress: Fannie Mae and Freddie Mac. These two organizations don’t create their own mortgages; rather, they buy mortgages from lenders and repackage them into something called Mortgage-Backed Securities (MBS).

While you likely don’t need to know all the inner workings of Fannie and Freddie’s long relationship with the housing market, it’s important to know that they make a big impact by “stabilizing mortgage markets and protecting housing during extraordinary periods when stress or turmoil in the broader financial system threaten the economy.”

Think back to the moratorium period on foreclosures and evictions during the Covid-19 pandemic – that was all thanks to Fannie Mae and Freddie Mac. 

5 Common Types of Home Loans

While there are many kinds of mortgages available, the five most common types include conventional mortgages, FHA loans, VA loans, USDA loans and Jumbo loans. Let’s explore the pros and cons of each of these options.

Related: How to Build a Plan to Save for Your First House

1. Conventional Mortgages

Remember ol’ Fran and Fred? I told you they’d be important!

A conventional mortgage is a home loan that meets the requirements set forth by Frannie Mae and Freddie Mac. These requirements include:

  • Down payments of at least 3% based on income and home type
  • Private Mortgage Insurance (PMI) for down payments less than 20%
  • A credit score of at least 620 
  • A debt-to-income ratio of 50% or lower
  • A loan amount of $647,200 for single-family homes in 2022 in most of the U.S.

There are fine-print details and rare exceptions to most of these rules, so be sure to check with your mortgage lender for any need-to-know specificities.

2. FHA Loans

FHA loans are mortgages insured by the Federal Housing Administration. In general, these loans are easier to qualify for than conventional loans. 

A few of the other perks you can expect with an FHA loan include:

  • Lower down payments
  • Lower closing costs
  • Easier qualifying

However, you can only use an FHA loan if you’re purchasing your own home and the property has four or less units. While there isn’t PMI attached to these loans, you should expect a Mortgage Insurance Premium (MIP). While private insurance can be canceled once you own a certain percentage of the home, MIP is there to stay for the entirety of the loan period.

3. VA Loans

Next up: VA loans. These mortgages are issued through private lenders but backed by the U.S. Department of Veteran Affairs. 

They offer little to no down payments and lax mortgage insurance requirements. VA loans can be used to purchase a home, build a home or even make improvements to an existing home.

The catch is that VA loans are specifically for veterans, active service members and/or their surviving spouses. If you or your partner spent time enlisted, you very well may qualify for this excellent mortgage option.

4. USDA Loans

USDA loans are a great mortgage option for those interested in a quieter life. These loans are backed by the U.S. Department of Agriculture and specifically designed to encourage people living in rural areas (or moving to rural areas) to buy homes. Sometimes you’ll find eligible homes in suburbs as well.

Priority for USDA loans goes to those in the most need, such as families with low income or an inability to qualify for conventional loans. They can also have stringent requirements about square footage and home value depending on the area.

But with low interest rates and no down payment, a USDA loan might just be your ticket to a great home deal.

5. Jumbo Loans 

Lastly, there’s the Jumbo loan. These are for homes that have been priced out of the Fannie Mae and Freddie Mac programs. In general, they’re high-end, luxury homes with long price tags. 

Jumbo loans have varying tax and underwriting requirements depending on the location and lender, and borrowers are expected to have stellar credit history and a low debt-to-income ratio. 

If you’re rolling in the riches and ready to move house, a Jumbo mortgage is the way to go.

Adjustable-rate Vs. Fixed Rate

A few more terms to have on your radar in your search for a mortgage are adjustable and fixed rate loans. These have to do with the interest rate charged on your home loan.

A fixed rate is just what it sounds like – a single rate you’ll pay throughout the life of the loan. 

On the other hand, an adjustable-rate mortgage (ARM) tends to have a lower initial interest rate that changes (usually becomes higher) over time.

There are different benefits of each type. For example, ARMs tend to be cheaper in the initial years of the loan. On the flip side, fixed rate mortgages make it easier to budget long-term. It’s best to speak with your financial advisor and mortgage lender to decide which type of mortgage rate is best for you.

The Reverse Mortgage

A reverse mortgage isn’t used to purchase a home. Rather, it’s a way homeowners can borrow money using their house as security.

You still live in the home and own the home, but whenever you move out or sell the house, you’ll have to repay the reverse mortgage amount plus interest and fees each month. As time goes on, the money you owe on your mortgage increases instead of decreases.

Start your homebuyer’s journey as a pro and secure the best mortgage option for your unique financial situation. Need more help getting started? We’d love to connect you with a financial advisor.

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