Searching for a mortgage is like searching for a home – they come in all shapes and sizes. When buying a home, people usually think about which area they want to buy and how much they’re willing to spend before approaching real estate agents. The same goes for mortgages: first, you need to know which type of mortgage you prefer before going shopping for a mortgage lender.
When it comes to purchasing a home, there are five main mortgage programs to choose from: conforming loans, jumbo loans, FHA loans, VA loans, and USDA loans.
After choosing your loan, there are other things you can do to configure the loan to your liking, including choosing the type of rate (fixed rate or adjustable rate) and repayment term (usually between 15 and 30 years, although some lenders go as low as eight years). All these choices, along with your own credit profile, go into determining how much you pay your mortgage lender each month.
If you’re refinancing, then you can choose from the above loans and a whole range of sub-categories like cash-out refinancing and FHA streamline refinancing, but that’s a topic for another time.
||Buyers of expensive properties
||Borrowers with poor credit
||Service members and veterans
||Buyers in rural areas
Conforming loans, also known as conventional loans, are the most common type of mortgage. This is a type of mortgage between the borrower and the lender, with no government backing.
Most lenders require at least a 20% down payment on a conventional mortgage so that if a home costs $300,000, you must pay at least $60,000 and borrow no more than $240,000. In recent years, an increasing number of lenders have begun offering conventional mortgages with a minimum down payment as low as 3% through the Freddie Mac HomePossible or Fannie Mae HomeReady loan programs.
Conventional loans usually have higher interest rates than government-backed loans with the same loan amount, but the lower closing costs make them cheaper on an annual percentage rate (APR) basis than FHA loans.
Jumbo loans are loans that exceed the legal conforming loan limits set by the Federal Housing Finance Agency (FHFA). In 2021, the limit is $548,250 in most counties but higher in expensive counties, reaching a maximum $822,375 in a handful of high-end zip codes (namely the New York, Washington, D.C., San Francisco, and Los Angeles metro areas, the states of Alaska and Hawaii in their entirety, and a few wealthy small towns).
Because jumbo loans involve higher loan amounts and therefore greater risk to the lender, they typically have stricter qualifying requirements. Jumbo loans virtually always require a 20% down payment, and in some cases, lenders have been known to require 25% or even 30%. Furthermore, jumbo loans usually require a minimum credit score of at least 680 to qualify, as opposed to 620 for other loans.
On the positive side, jumbo loans are often cheaper than conforming loans. Of course, with the higher loan amount, the borrower almost always ends up paying more to the lender over the life of the loan than they would for a regular loan, so lenders can afford to be a little generous on the interest rate.
FHA loans are government-backed loans administered by the Federal Housing Administration for buyers with poor credit or little money for a down payment. Like other government-backed loans, these loans are issued and underwritten by private lenders in accordance with the government’s rules.
In the case of FHA loans, borrowers with credit of 580-619 may obtain a loan with 3.5% down payment while borrowers with 500-579 credit may obtain a loan with 10% down payment. Many FHA-authorized lenders only work with borrowers with 580 credit, but if you search hard enough you’ll find a few that cater to the 500-579 group.
The most important thing to know before taking an FHA loan is that it requires private mortgage insurance (PMI). This is typically broken down into two components: a one-time fee worth 1.75% of the loan amount which you can pay upfront or roll into your monthly payments; and a monthly premium varying from 0.45% to 1.05% of the loan amount per year. Therefore, while the interest rates on FHA loans are usually lower than conventional loans, the APR (the entire cost of the loan on an annualized basis) is typically higher.
VA loans are government-backed loans administered by the Department of Veteran Affairs (VA). The following people may apply for a VA loan: veterans who have served at least 90 consecutive days of active service in wartime or 181 days of active service in peacetime; members of the National Guard and Reserve who have served at least 6 years; and spouses of veterans who died in the line of duty or as a consequence of a service-related injury. In order to apply for VA loan, you must show your lender a Certificate of Eligibility from the VA showing you meet one of the above requirements.
The minimum credit requirement for a VA loan is usually 620+ although some VA-authorized lenders have been known to accept 580-600 or in rare cases 500. The biggest benefit to a VA loan is that there’s no down payment and no PMI requirement.
VA loans carry a funding fee of 1.4%-3.6% of the loan amount, with the exact amount determined by the type of VA loan and size of the down payment (if you choose to put money down). Certain borrowers, such as surviving spouses and veterans receiving VA disability compensation, are exempt from the VA funding fee.
Despite the funding fee, other factors – namely the lack of PMI requirement, lower overall closing costs, and lower-than-average interest rates – make VA loans the cheapest mortgage product overall.
USDA loans are government-backed loans administered by the U.S. Department of Agriculture’s Rural Housing Service. The purpose of USDA loans is to provide homeownership opportunities to low-to-moderate income households in rural and semi-rural areas throughout the United States.
There are two main eligibility requirements for USDA loans: your home must be in a qualified rural area, typically defined as a location with less than 20,000 people; and your income must be no more than 115% of the adjusted area median income (AMI), i.e., if the AMI in your area is $60,000, your income cannot exceed $69,000 per year. Like VA loans, USDA loans can finance 100% of a home’s purchase price without any need for a down payment or mortgage insurance.
USDA loans may be used for a variety of purposes, including:
- Site preparation costs (grading, foundation plantings, seeding etc.).
- Special design features or permanently installed equipment to accommodate a household member with a physical disability.
- New or existing residential property to be used as permanent residence.
Now that you’ve had a thorough rundown of what each loan offers borrowers, we hope you’re now able to make an informed decision about which loan is best for you. The next step is to find a lender that can offer a loan program, loan amount, and interest rate to suit your financial profile and preferences.