Types Of Home Loans: A Guide For Buying Or Refinancing Your Home

Purchasing or refinancing a home may seem overwhelming, because of the numerous types of home loans that are accessible. However, having a range of mortgages can assist you in finding the most suitable home financing option for your goals.

Conforming Vs. Non-Conforming Loans

The two main categories that mortgages fall into are conforming and nonconforming loans, which are determined by whether they meet the guidelines set by government-sponsored enterprises (SGSEs) Fannie Mae and Freddie Mac.

Conforming Loan Requirements

Conforming loans are mortgages that meet the guidelines set by GSEs. Lenders that specialize in conforming loans underwrite and finance them, which are then sold to investors such as Fannie Mae and Freddie Mac. The loans are then securitized and offered to investors on the open markets. Due to their liquidity and compliance with government regulations, conforming loans typically carry lower interest rates compared to non-conforming loans. For a loan to be considered conforming, it must meet specific requirements established by the Federal Housing Finance Agency (FHFA) including:

• Credit score: In order to qualify for a conforming loan, a client must meet the credit score requirement of 620 or higher. Negative credit marks may also impact eligibility.
• Debt-to-income ratio (DTI): Calculating your debt-to-income ratio (DTI) is crucial to determining your house's affordable range. Your DTI ratio compares your monthly gross income with all monthly debts, including installment debts such as a mortgage, student loans and car payments, and revolving debts such as credit card bills. Mortgage lenders use this ratio to assess your financial capacity to pay off your loan.
• Loan limits: The conforming loan limit for a single-unit property in 2023 is generally $726,200 in most areas of the country. However, if you reside in a high-cost area, like Alaska and Hawaii, the limits are determined based on the county, ranging up to a maximum of $1,089,300. For properties with multiple units, loan limits are higher.

Understanding The Most Common Types Of Home Loans

The type of mortgage loan you can obtain depends on various factors, including the property's classification, your income, credit score, and the minimum down payments required for different loans.

Conventional loans, which are not insured or guaranteed by the government, usually have stricter qualifying criteria compared to government-backed loans. Lenders typically require a higher credit score, stable income, and a lower debt-to-income ratio for these loans. However, conventional loans may offer more flexibility in terms of loan terms, interest rates, and borrowing limits.

It's worth noting that government-backed loans are insured or guaranteed by agencies like the Federal Housing Administration (FHA), the U.S. Department of Veterans Affairs (VA), or the U.S. Department of Agriculture (USDA). These types of loans are specifically designed to help those borrowers who may not qualify for conventional loans. Government-backed loans come with more relaxed qualifying criteria and allow borrowers to make a smaller down payment.

The classification of a home property as a primary residence, secondary residence, or investment property can have an impact on the type of loan you choose to take. For instance, primary residences usually come with lower interest rates, lower down payment requirements, and fewer restrictions compared to second homes and investment properties. In case you are looking to invest in these higher-risk properties, you may consider opting for a loan that offers the lowest down payment requirement or a longer term to have more financial flexibility.

Conventional Loans

Conventional loans offer various features. To be eligible for a conventional loan, you need to have a FICO® Score of at least 620. Your application for a mortgage might not be approved if your monthly debt payments exceed half of your gross monthly income. If you're a first-time home buyer, you can purchase a primary property with just a 3% down payment. However, if you make a down payment of less than 20%, you'll have to pay for private mortgage insurance (PMI). The good news is that once you reach 20% equity, you can request that PMI be canceled after an appraiser confirms that the property has not decreased in value.

Jumbo Loans

A jumbo loan is a type of mortgage that exceeds the conforming loan limits set by the FHFA and is used to finance high-value properties over the conforming loan limit.

VA Loans

VA loans are a type of mortgage that is available to eligible active-duty service members, reservists, veterans, and surviving spouses of those who passed away while on active-duty or as a result of a service-connected disability. The best part is that VA loans don't require a down payment, making them a great option for those who are unable to put money down upfront. Although the VA doesn't set specific guidelines for credit scores, lenders have their own policies. For instance, Rocket Mortgage® requires a minimum credit score of 580 to be eligible for a VA loan.

FHA Loans

If you have less-than-perfect credit, FHA loans can help you qualify for a mortgage. You can get an FHA loan even if your credit score is as low as 500. However, note that you'll need to make a 10% down payment; only a few lenders offer this option. Most lenders, including Rocket Mortgage, require a qualifying score of 580, and you'll need a 3.5% down payment to get an FHA mortgage.

USDA Loans

If you are looking to purchase a property in a rural area or on the outskirts of a suburb, and your income meets the qualifying guidelines, USDA loans are available to assist you with financing. You can purchase a one-unit property without any down payment, as long as you meet the income requirements. It's important to note that Rocket Mortgage does not offer USDA loans at this time.

Rates And Terms For Different Types Of Home Loans

When it comes to obtaining a mortgage, you usually have two interest rate structures to choose from: a fixed-rate mortgage or an adjustable-rate mortgage. A fixed-rate mortgage is characterized by an interest rate that remains the same throughout the entire loan term. On the other hand, an adjustable-rate mortgage has an interest rate that fluctuates based on market conditions and is subject to caps on increases.

The phrase "mortgage terms" technically refers to any contract provisions associated with a mortgage. However, in most cases, it specifically refers to the amount of time you have to pay off the loan. Now, let's take a closer look at these structures and mortgage terms.

Fixed-Rate Mortgages

A fixed-rate mortgage is a kind of home loan where the interest rate remains unchanged for the entire duration of the loan. As a result, the monthly principal and interest payments remain constant throughout the life of the loan. Fixed-rate mortgages can be a favorable option for borrowers for a multitude of reasons:

1. They provide stability and predictability, as borrowers know exactly how much they need to pay on their principal and interest each month. This can help with budgeting and financial planning.
2. Fixed-rate mortgages protect borrowers from rising interest rates in the future, as their rate is locked in. This can be particularly beneficial when interest rates are low and expected to rise.
3. Fixed-rate mortgages offer peace of mind to borrowers, as they don't have to worry about fluctuations in their principal and interest portion of their monthly payment – the escrow portion for taxes and insurance may change annually. This can provide a sense of security and reduce financial stress.
4. Fixed-rate mortgages are often available in various terms, allowing borrowers to choose a loan duration that suits their needs and financial goals.
5. Fixed-rate mortgages can be advantageous for borrowers who plan to stay in their home for a long time, as they can enjoy the same interest rate and principal payment for the entire term of the loan, regardless of market conditions.

Adjustable-Rate Mortgages (ARM)

Adjustable-rate mortgages (ARMs) are loans with interest rates that change over time but not immediately. At the start of the loan, there is an introductory period that lasts around 5, 7, or 10 years, during which the interest rate remains fixed. After this period ends, the interest rate adjusts up or down based on market conditions, typically once or twice per year.

When a loan rate is adjusted, it’s linked to a market index. The Secured Overnight Financing Rate (SOFR) is used as the basis for conventional loans. The rate is based on the 1-Year Constant Maturity Treasury for government loans provided by the FHA and VA. The index level on the day of adjustment is added to a margin to arrive at the final rate.

When considering mortgage options, an ARM might seem like a good choice for some borrowers. One advantage of ARMs is that they typically offer lower initial interest rates than fixed-rate mortgages, resulting in lower monthly payments during the initial loan period. This can be beneficial for borrowers who plan to sell the property or refinance before the fixed-rate period ends. ARMs also provide flexibility to borrowers who anticipate an increase in income or changes in their financial situation. If you expect your income to rise in the future, an ARM can be a suitable option, as you can take advantage of the lower initial rates and then refinance or sell the property before the rate adjusts. This allows you to benefit from the lower payments early on and potentially avoid higher interest rates in the future.

Mortgage Terms

When you decide to take out a mortgage, you are committing to a long-term relationship with the lender. The mortgage term refers to the duration of the loan or the time during which the loan stays active. It is a crucial factor to consider when selecting a home loan. The most popular mortgage terms are:

• 30 years: The most common option for many home buyers is a 30-year mortgage term. It provides a longer repayment period, resulting in lower monthly payments compared to shorter terms. This can be advantageous if you prefer having more cash flow available each month or if you are looking for a more affordable monthly payment. It is the cheapest monthly payment you can get if all other things are equal because it spreads the principal payments throughout 30 years With a lower monthly payment, you have a level of greater flexibility. You can also make extra payments toward the principal to pay less interest over time and reduce the loan's duration. However, ensure that you are aware of whether your lender charges prepayment penalties and for how long.
• 15 years: A 15-year term can help you pay off your loan in half the time. Although the monthly payments may be higher, you can save a significant amount of money in interest over the life of the loan. This option is ideal for borrowers who want to build equity quickly and pay off their mortgage sooner. With a shorter payoff time frame, you'll end up paying less interest in exchange for giving the investor a quicker payoff. Additionally, you can benefit from a lower interest rate.
• 20 – 25 years: Opting for a mortgage term of 20 – 25 years can be a wise decision as it offers a balance between lower monthly payments and a shorter repayment period. This option is often preferred by borrowers who intend to pay off their loan faster than a 30-year term but still want to retain some flexibility with their monthly budget. It's worth noting that this option may also be available for certain government-backed loans.
• Custom terms: Custom loan terms are available from some lenders to cater to individual preferences. This allows borrowers to choose a mortgage term that aligns with their specific financial goals and circumstances. Custom terms can be particularly beneficial for those with unique situations or who want to tailor their loan to fit their specific needs. On the conventional side, you have the option of a fixed-rate term of anywhere between 8 – 29 years, providing you with plenty of flexibility to customize your loan. This flexible loan, offered by Rocket Mortgage, is known as YOURgage®, which allows you to pick your exact term, potentially enabling you to reduce the length of your term while still being comfortable with your payments.

The Bottom Line: Your Mortgage Should Work For You

When it comes to financing a house, there are a variety of loans available to meet your unique needs and goals. To make an informed decision about which one is best for you, it's important to learn more about each option. Keep in mind that the home loan you choose should be tailored to your needs. If you're ready to begin the mortgage application process, you can speak with an expert today.