Owning a home is a considerable investment. Most of us can never pay out of pocket and need financial help.
To find the right mortgage, you need to do some research.
Each loan has its unique risks and benefits. Learning about what to expect before approaching a mortgage lender will help you navigate the selections they offer.
In today’s post, we’ll discuss the most common conventional and government loans—what they are and who qualifies.
I | Private Lenders and Banks (Conventional Loans)
Conventional Mortgage
Conventional loans are popular among homebuyers. Private lenders and banks offer these mortgages, and the federal government doesn’t back them. Although conventional home loans are the most common type, they have stricter eligibility requirements.
The Types
Conventional mortgages come in two forms: conforming and non-conforming.
- Conforming loans follow the loan standards set by the Federal Housing Finance Agency (FHFA). The FHFA sets the conforming loan limits every year; in 2022, the limit is $647,200. This figure represents an increase of $98,950 from $548,250 in 2021. (Source)
- Non-conforming loans don’t conform to FHFA loan standards. Lenders often offer these mortgages to borrowers with financial issues like poor credit scores and those who’ve suffered bankruptcy.
Pros
- Down payments as low as 3%
- Lower mortgage insurance rate than other loan types the FHA offers
- Upfront borrowing cost after calculated fees and interest is generally lower than unconventional loans (even if the interest rate is higher)
- No mandatory mortgage insurance premiums (you can cancel private mortgage insurance (PMI) once you pay down 20% of the mortgage’s principal)
- Closing costs contribution by the seller
Cons
- Stricter conditions on a borrower’s debt-to-income (DTI) ratio
- A minimum credit score requirement of at least 620
- Private mortgage insurance (PMI) applies to down payments lower than 20%
If you have strong credit, low DTI, a stable income, and the first 20%, take advantage of a lower mortgage interest rate and no PMI.
Fixed-rate Mortgage Loans
The interest rate on fixed-rate loans remains the same for the loan’s entire life. Your monthly mortgage payment won’t change, no matter the fluctuations in the financial market.
Lenders offer 10, 15, and 30-year term mortgages.
Pros
- Predictable monthly payments simplify budgeting your expenses month-to-month without worrying about spontaneous increases
- Not overly susceptible to market conditions
Cons
- You pay more interest with a longer repayment term if the rates are high
- Interest rates are higher than adjustable-rate mortgages (ARMs)
- An increase may occur if there’s an increase in property taxes or insurance rates
- Once you sign up for a fixed rate, you’re stuck with it for the loan term unless you refinance
Fixed loans work for homeowners who plan on living in their homes for the foreseeable future. A fixed-rate mortgage can also work for refinancing your mortgage and locking in a lower interest rate than you had before.
Adjustable-rate Mortgage
On the opposite end of fixed-rate mortgages, we have adjustable-rate mortgages. As the name suggests, the rates fluctuate. However, this change doesn’t begin until after an introductory rate period when the rate remains fixed.
For example, a 5/1 ARM loan gives you five years at a fixed rate; annual changes kick in after the initial fixed-rate period. A 7/6 ARM loan locks your rate in for seven years until it starts adjusting every six months.
Once the fixed period ends, how much you pay per month changes with the current market rate. The variable interest rate can drop, lowering your payments, or they can soar, which might upend your budget.
Rate caps protect you from extreme increases. Once your rate hits the limit, it’ll stop increasing.
Pros
- Lower fixed rate for the introductory period (5, 7, or 10 years) before periodic adjustments begin annually, every six months, etc.
- Attractive savings at the start of the loan
Cons
- An increase in market rates will skyrocket your monthly payments, which increases the risk of defaulting
- Missed or late payments tarnish your credit history and affect future financial goals
- Poor credit score affects your chances of refinancing at a reasonable rate to avoid the adjustment period
Adjustable-rate loans are a good choice for homebuyers who don’t plan on living in their home beyond the introductory period. If you live in your home longer than planned, you’ll need to refinance to avoid adjusting rates once it resets.
Read the fine print for an estimate of the possible rate of increase at the end of the introductory period.
Jumbo Loans
Jumbo home loans surpass the FHFA conforming limits in an area. They’re popular in higher-cost places like California, New York, Massachusetts, and Utah, where home values are high.
Jumbo loan limits vary by location and change, like conforming loan limits.
Pros
- Can have fixed or adjustable loan interest rates
- Interest rates are competitive with conforming/conventional loans
- You can borrow more money to buy an expensive home
Cons
Strict qualification requirements of a minimum credit score of 700 or higher and a DTI of 45% or less
- You need to prove that you have a significant cash reserve
- Large downpayment of 10 – 20%
- A stricter appraisal process for the home you want to purchase
- Higher closing costs after fees
Jumbo mortgages are for prospective homebuyers who want to buy an expensive home that exceeds conforming limits in their area. Suppose you have excellent credit and proof of significant assets, and a steady income. In that case, you may qualify for one of these lines of credit.
II | Government-Backed Loans
Government-backed mortgages fall under three government agencies: the U.S. Department of Veterans Affairs (VA), the Federal Housing Administration (FHA), and the U.S. Department of Agriculture (USDA).
These federal agencies help millions of Americans who don’t qualify for conventional loans become homeowners. Each has specific benchmarks for qualifications, benefits, and saving opportunities.
FHA Loans
Backed by the Federal Housing Administration, FHA mortgages make homeownership possible without a large down payment or spotless credit.
Unlike USDA and VA mortgages, FHA has no restrictions on who can apply. Anyone can sign up and receive a loan if they meet the minimum qualification requirements.
Pros
- You don’t need a large down payment with a percentage as low as 3.5%
- Credit requirements start at 580 with a DTI of 43%
- Borrowers with scores as low as 500-579 can still qualify with a 10% downpayment
- Sellers can contribute to closing costs
- Created for borrowers from modest-income households
Cons
- Mortgage insurance premiums increase the overall cost of the loan. Unlike PMI, this insurance is mandatory and permanent unless you refinance into a conventional loan
USDA Loans
The United States Department of Agriculture (USDA) provides lines of credit to low-to-moderate-income borrowers in rural areas.
Pros
- Some options don’t require a downpayment for eligible borrowers
- Offers lower mortgage insurance requirements than FHA
- Home improvement loans and grants are available
Cons
- Only available to borrowers living in a USDA-eligible area (suburban or rural)
- There is an upfront fee of 1% and an annual fee
- Income limit applies based on the number of members in the household. For example, the 2022 limit for 1-4 member households is $103,500, and for 5-8 member households, it’s $136,600 (Source)
- There is a cap on property value
USDA loans are for income-qualified buyers looking for homes in rural and some suburban areas without worrying about a down payment.
VA Loans
The Department of Veterans Affairs (VA) offers loans to members of the U.S. military (active duty and veterans) and their families.
Pros
- No mortgage insurance or downpayment required
- No minimum credit score
- Lower interest rate than the other types of loans on this list
- Capped closing costs payable by the seller
- Flexible borrowing options
Cons
- Depending on loan usage and other factors, you may have to pay a loan funding fee. (Source)
The VA loan is for eligible military personnel and their families who want to buy a home with a 0% down payment and no mortgage insurance. Service requirements apply.
Conclusion
There are mortgage loans on the market to meet most Americans’ needs. You can choose to take the conventional route.
- Conventional: if you have the first 20% for a downpayment to make the most use of your excellent credit for favorable rates
- Fixed-Rate: to keep your rate steady and safe from most external factors for the life of the loan.
- Adjustable-Rate: to take advantage of the initial low-interest rate, but at the risk of fluctuating rates after the introductory period.
- Jumbo: for high-priced properties that break the conforming limit in the area you want to live in.
There are government-backed options if your credit and debt can’t stand up to the requirements of private lenders and banks.
- FHA: if your credit score isn’t the best, but you still want to own your own home with the lowest downpayment possible
- USDA: if you want to live in a rural area or suburb where it’s available, and your household income meets the requirements
- VA: to use the benefits of your military service and get a mortgage with no downpayment or minimum credit requirements
Start with the list above and assess which type of mortgage loan best suit you. Weigh the pros and cons to make the wisest financial decision.
