What Are the Different Types of Mortgage Loans?
Purchasing a new home is exciting, but it can also be an overwhelming process to navigate on your own, especially for a first-time homebuyer. It can help to know about the different mortgage loans available so that you will be better able to choose one that will fit your needs and budget. Below, we will explore the most common types of loans for mortgages.
1. Conventional Loans
These loans aren’t secured by the federal government but rather through a private lender or Freddie Mac or Fanny Mae, two agencies that are sponsored by the government. Loans that adhere to the limits set by Freddie Mac or Fanny Mae are known as conforming loans while non-conforming loans fall outside the preset guidelines. Conventional loans are good for borrowers with a good credit history, a solid employment background, and a minimum down payment of 3 percent.
Conventional mortgage lenders typically require borrowers to pay private mortgage insurance (PMI) when the down payment is less than 20 percent of the purchase price of the home. This insurance helps buyers get access to a wider range of homes with a reduced down payment. Lenders assume the risk because the insurance protects them in the event that the buyer defaults on the loan.
The minimum FICO score for a conventional loan is 620, but the better your credit is, the lower your rates will be for your mortgage loan and private mortgage insurance. If your score is hovering around 620, it could pay off to take some actions to boost your score before applying for a loan. Borrowers with scores of 680 or above will find much more favorable terms that can save them thousands of dollars over the life of their loan.
2. Government-Insured Loans
Loans that are guaranteed by the government are designed to give more Americans the opportunity to become homeowners. These loans help people who would not normally qualify for a conventional loan due to the credit, income, and/or down payment restrictions. The government secures loans by the following agencies:
- Federal Housing Administration (FHA)
- S. Department of Agriculture (USDA)
- S. Department of Veterans Affairs (VA)
FHA loans are very popular among first-time borrowers who don’t have a lot of cash saved to make a large down payment on their home. These types of loans are also appealing to those with less-than-perfect credit as they only require a minimum FICO score of 580 for a traditional FHA loan with 3.5 percent down. FHA loans do require a Mortgage Insurance Premium (MIP) from the borrower. This consists of a fee that’s paid upfront at the closing as well as a premium that’s added into the monthly mortgage payments. Like a PMI, this premium protects the lender from losing money should a borrower stop making payments on their loan.
People with credit scores as low as 500 can also qualify for FHA loans, but they will be required to put 10 percent down on the home. These borrowers might find it more beneficial to use those funds to work on improving their credit score so that they can qualify for the better 3.5-percent offer.