What are the Different Types of Home Loans?
Point of Interest
Whether you’re a first-time homebuyer or have owned your own home for years, finding the right mortgage for a new home purchase or refinance is no small feat. Every borrower is different, and understanding all of your options is the first step to figuring out what types of home loans may work best for you. Government-backed FHA, VA and USDA loans offer unique perks for those who meet their eligibility requirements, while conventional fixed and adjustable-rate loans offer competitive rates and terms.
For many people, homeownership is a significant milestone. And, while finding your dream home may be a fun and exciting process, financing it can be somewhat less thrilling. Thankfully, homebuyers have a variety of options available to choose from when financing a new home — many of which give buyers the financial flexibility they need, regardless of their credit score.
Different types of mortgages
While there are many mortgage and loan types for people to choose from, the six most common are:
- Adjustable-rate (ARM)
- Jumbo loans
Different types of home loans
Best for: Medium to high-income homebuyers
Conventional loans, referred to as either conforming or non-conforming, are traditional mortgages provided by banks, credit unions and other financial institutions. A government agency does not back these loans, so they often have higher rates and closing costs. To be approved for a conventional loan, most applicants will need to maintain a FICO score of at least 660 and have a debt-to-income ratio of 45% to 50%. Conventional loans are ideal for individuals with fair to excellent credit ratings, steady income and those who can make a down payment of at least 3%.
- Easy to find and offered by most lenders
- Borrowers can choose between fixed and adjustable-rate options
- Government-backed loans may offer lower rates and closing costs
- Often require a higher down payment
Best for: First-time homebuyers
An FHA loan, otherwise known as a Federal Housing Administration loan, allows homebuyers to borrow up to 96.5% of a property’s value. FHA loans are federally backed and easier to apply for than conventional loans because they require lower credit scores and lower down payments. Individuals applying for an FHA loan should have a minimum FICO score of 580 and a debt-to-income ratio of 31% to 43%, though the requirements will vary by lender. FHA mortgages are ideal for first-time buyers or those with low to moderate income.
- Low down payment requirement
- Easier approval for borrowers with lower credit scores
- Borrowers will have to pay for mortgage insurance for an extended period of time as a requirement of FHA loans
- Opting for the minimum down payment can lengthen the life of the loan
Best for: Low-income buyers in rural and suburban areas
USDA loans are mortgages that require no down payment and are made available to eligible rural and suburban homebuyers. These mortgages are issued through the USDA Rural Development program and are government-backed, so the credit and income requirements for this type of loan are much looser than conventional loans. While most buyers may not think their home is eligible, USDA loans are available to 97% of U.S. residents.
These are typically reserved for low-income applicants and come with interest rates as low as 1% once approved. The minimum credit score required for these loans is usually 640. However, you can often qualify with less than adequate credit history by meeting other requirements.
- Significantly lower rates for those who qualify
- Low-income borrowers are prioritized
- Income limits and geographic restrictions apply
- Mortgage insurance is required
Best for: Military families
VA loans, otherwise known as Veterans Affairs loans, are issued by private lenders and are insured by the Department of Veterans Affairs. VA loans are designed for veterans, active-duty military personnel, and their spouses, so long as they meet specific eligibility requirements. Some military Reservists or National Guard members may be eligible as well.
VA loans do not require a down payment, and often feature competitive rates with no mortgage insurance requirements. There is also no minimum credit score requirement, though most lenders like to see a FICO score of at least 620.
- Borrowers can opt for 0% down
- No PMI (private mortgage insurance) is required
- Borrowers need a COE (certificate of eligibility) from the VA before applying
- Can involve extra closing costs and fees
Fixed-rate conventional loans
Best for: Long-term homeowners
A fixed-rate loan is a type of mortgage loan with interest rates that do not change over time. Fixed-rate loans are often the preferred method of financing for homeowners, as monthly payments stay the same regardless of changing market conditions. Most fixed-rate conventional loans come with 15- or 30-year terms with principal and interest payments that stay the same over the life of the loan. The downside of a fixed-rate mortgage is that it takes longer to build equity in a home.
Fixed-rate mortgage loans are an excellent choice for individuals who budget and prefer the predictability that a fixed-rate loan provides. While borrowers may miss out if interest rates drop, they are protected from higher payments if rates go up. Typically, individuals applying for a fixed-rate loan will need to have a FICO score of at least 650, though it will vary by lender. However, those with lower credit profiles may be approved by paying higher rates.
- Predictable payments make it easy to budget and plan ahead
- Less complicated than adjustable-rate loans
- Often come with a higher price tag than adjustable-rate loans
- Lenders may require higher credit scores to qualify for fixed-rate loans
Best for: Real estate investors and short-term buyers
Adjustable-rate mortgages, otherwise known as ARM or variable mortgages, are home loans with interest rates that fluctuate based on current market standards. ARMs will typically have fixed-interest periods for a set amount of time, with interest rates that vary once this period ends. For example, a 5/1 ARM will have a fixed interest rate for five years and then fluctuate year thereafter. Most adjustable-rate mortgages have between 3- and 10-year terms, but options can vary widely.
Most ARMs will come with certain rate caps that restrict rates from going too high from one year to the next, regardless of how the indexes are analyzed. The minimum FICO score required for conventional ARMs is typically between 620 and 680. Adjustable-rate mortgages are best suited for short-term homeowners who don’t plan on living in their property long enough for their rates to rise.
- Typically offer lower rates than fixed-rate mortgages during the “fixed” period of the loan
- Borrowers will benefit from a lower rate if market rates drop
- Borrowers aren’t protected from higher payments if interest rates increase
- Applying for an ARM loan can be more complicated than a fixed-rate mortgage loan
Best for: High-income buyers
Non-conforming mortgage loans, which are often called jumbo loans, are mortgages in amounts higher than the loan limits set by the federal government. The Federal Housing Finance Agency (FHFA) loan limit is currently $510,400 for the year 2020, meaning any mortgage loans taken out for more than that amount can’t be purchased or secured by Fannie Mae or Freddie Mac. There are exceptions to this rule, though, for buyers who live in high-cost areas. The loan limit for one-unit properties in most high-cost areas is $765,600 for 2020, or 150% of the normal limit of $510,400.
Jumbo loans are most often used to either purchase homes in high-cost areas or buy luxury properties. These types of loans come with stricter requirements for applicants, and generally require excellent credit and a low debt-to-income ratio. In some cases, lenders may ask to see up to 18 months worth of payments in reserve before approving potential borrowers. Jumbo loans are best suited to borrowers with excellent credit who plan to buy a home with a high price tag.
- Provide larger loan amounts for more expensive homes
- Can opt for fixed-rate, ARM, or VA jumbo loans
- Can be difficult to qualify for with higher credit and income requirements
- Common to see lenders require for 20% down or higher