Applying for a mortgage loan can be overwhelming. As lenders throw different terms at you, it’s easy for you to get confused. Before you even shop for a mortgage, you should know the type of loans available so that you can make the right choice for you before you even shop for a home.
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Below we discuss the various options available for you to learn the options that may be available to you.
Conventional Loans, Government-Backed Loans, and Subprime Loans
First, let’s consider the type of mortgage you should consider. The most common options are conventional and government-backed loans. If you don’t meet the requirements of either type of these loans, you can opt for a subprime loan.
Conventional loans are loans sold to Fannie Mae and Freddie Mac. They are your ‘general loans,’ that most lenders offer. Typically, you have to have good credit, low debt ratios, and a decent down payment to qualify for this program. In other words, the requirements are the toughest for these programs.
You’ll need at least a 5% down payment for these loans. If you do opt to put down less than 20% on the home, expect to pay Private Mortgage Insurance until you owe less than 80% of the home’s value. If you do put less than 20% down on the home, lenders tend to be a little more cautious about your credit scores and debt ratios, as you pose a higher risk with a higher LTV.
Government-backed loans are those backed by a government agency. The options include FHA, VA, and USDA loans.
- FHA loans – FHA loans are backed by the Federal Housing Authority. With a 580 credit score, 31% housing ratio, 43% total debt ratio, and 3.5% down on the home, you may be a good candidate for this program. You don’t have to be a first-time homebuyer to secure this loan program, as many people believe. Note that you will pay an upfront mortgage insurance premium plus mortgage insurance for the life of the loan, no matter your LTV.
- VA loans – Veterans that served at least 90 days during wartime and 181 days during peacetime may be eligible for a VA loan as long as they had an honorable discharge. This loan program doesn’t require a down payment. It also has flexible underwriting guidelines, allowing credit scores as low as 620 and debt ratios as high as 43%. The largest qualifying factor is the need to meet the VA’s disposable income requirements based on your location and family size. You will not pay any mortgage insurance for this loan.
- USDA loans – Low to moderate-income families that don’t qualify for any other mortgage program may qualify for the USDA loan. The catch is that you have to buy a home in a rural area. The USDA is liberal with their rural boundaries, though. The USDA requires a 640 credit score; 29% housing ratio, and 41% total debt ratio. You will pay an upfront mortgage insurance fee as well as annual insurance for the life of the USDA loan.
Subprime loans are those that don’t fit in the conventional or government-backed loan programs. These loans are provided and held by private lenders. They don’t sell them on the secondary market. This allows the lender to set their own requirements, which may provide you with more options for qualifying. For example, some lenders allow the use of bank statements rather than tax returns for self-employed borrowers. This gives self-employed borrowers a greater chance of qualifying for the loan. Subprime lenders may also allow lower credit scores, higher debt ratios, or make other exceptions that conventional and government-backed lenders cannot provide.
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Finally, if you need a loan amount that exceeds the standard conforming limit, you will need a jumbo loan. This year, these loans exceed $453,100. These loans usually have stricter guidelines than even conventional loans require because of the higher risk of the high loan amount.
You should expect to need a great credit score, low debt ratio, and a large down payment. The requirements will vary by lender, though, so make sure you shop around.
Fixed Rate and Adjustable Rate Loans
Once you determine the type of loan you need/want, you’ll need to look at the type of interest rate you can choose. You’ll hear lenders talk about fixed interest rates and adjustable interest rates.
Fixed interest rates are fixed for the life of the loan. The rate you get at the closing is the rate you keep as long as you keep the loan. It doesn’t matter what happens in the market – your rate never changes. You can usually opt for a fixed rate between 15 and 30 years, but the exact term depends on your qualifying factors and what the lender offers.
Fixed interest rates offer predictability. They never change, so you can always budget for your payment. The downside, though, is if you take the mortgage during a period of higher interest rates, you are stuck with that rate for the life of the loan.
Adjustable rate loans are fixed for a short period and then they adjust, usually on an annual basis. You can usually lock in the ‘introductory rate’ for 3 to 10 years. After that point, the rate is based on the chosen market index of the lender plus the predetermined margin.
The benefit of the ARM loan is the lower interest rate you get for the first few years. This rate is usually lower than the fixed interest rates at the time, allowing you to save money on interest for a few years. The downside is that you cannot predict what interest rates will do in the future, so you don’t know what your payment will be in the future.
Choosing the right loan program is important as it will determine your ability to qualify for the loan as well as afford the payments. Make sure you exhaust all of your loan options and compare them side-by-side so that you can determine the best option for you.