Getting a mortgage can seem complicated, once borrowers realize that there are several different types. With this information, potential home buyers will be able to distinguish the most common kinds of mortgages.
1. Fixed-Rate Loans
The standard mortgage loan that most people are at least vaguely familiar with is a fixed-rate loan with a specific term. The phrase “fixed-rate” means that the interest rate and the monthly mortgage payment are fixed for the duration of the loan. The term for a fixed-rate loan could be as low as 5-10 years but is typically either 15 or 30 years long. Although the borrower will pay down increasingly more principal on the loan over the years, the total payment for the principal and interest stays the same. Payments for private mortgage insurance, homeowners insurance, or property taxes may change, but the amount due for the loan itself does not. Fixed-rate loans are often preferred because they give buyers the benefit of predictability.
2. Adjustable-Rate Mortgages
Many people treat the fixed-rate mortgage as if it is the best mortgage available, but there are reasons people might consider an adjustable-rate mortgage (ARM). With an ARM, borrowers are often granted a lower introductory interest rate, which may generate a lower initial monthly payment. After a set period (usually at least a few years long), the interest rate and the monthly payment adjusts. This cycle is repeated at a defined interval, which may be every six months or a year. Although mortgage interest rates do not tend to fluctuate greatly from one month to the next, interest rates could rise significantly over a period of several years. As such, many people who start with an ARM eventually refinance their mortgages to a fixed-rate loan.
3. Conventional Lending
When home buyers start to look at homes, they may see references to the types of lending that sellers will consider. Conventional loans are frequently cited as preferred, so borrowers should understand the limits of this designation. Conventional loans are also sometimes called “conforming loans,” which means that they conform to the lending guidelines set by Fannie Mae and Freddie Mac. These are government-run organizations that buy up debt generated through conforming loans. Conventional lending usually carries specific requirements for down payments, assets in reserve, maximum debt-to-income ratio, and a limit on the size of the mortgage. Loans that fall outside conventional lending standards but are not in another specific category may be referred to as “nonconforming loans.”
4. Government-Insured Mortgages
In addition to conventional loans, potential home buyers may read about certain mortgages indicated by acronyms like FHA, VA, or USDA. These loans are insured by various departments within the federal government. The Federal Housing Administration guarantees loans for borrowers with limited ability to access conventional lending options. The Department of Veterans Affairs insures loans for current or former members of the military, with low down payment choices as a benefit of a certain amount of military service. The United States Department of Agriculture provides a guarantee for lenders who offer up to 100 percent financing for people who want to buy a home in rural areas. These loans may carry requirements above and beyond that of conventional lending, so they may not always be the ideal choice.
Choosing a mortgage means that borrowers need to know what is available to them. By understanding the difference between these types of mortgages, people can determine which mortgage will be best for their financial plans.