Inside: Learn about the most popular types of mortgage loans and decide which is the best for you.
When we bought our first home, there were a few well-known mortgage loan options we were aware of such as a conventional loan and an ARM. By the time we bought our second home, pre-2008, there were far more loan options available, for better or worse.
While there are still many different types of home mortgages available, there are a few that have withstood the test of time and are popular for a reason.
Fixed rate mortgage
The fixed rate, or conventional mortgage, is the most common type of mortgage loan available and the one most people are familiar with.
A fixed-rate mortgage has a set interest rate for the life of the loan. The most common length for a fixed-rate mortgage is a 30-year loan, followed by a 15-year loan. Besides those, you can also find 10-year, 20-year, and even 40-year or 50-year loans.
The primary benefit of a fixed-rate mortgage is that the payments stay the same for the life of the loan. This means your monthly payments are predictable and planning your budget is easier.
Often times a down payment of at least 5% is required, but it is possible to find conventional loans with as little as 3% down. With down payments of less than 20% of the home’s value, private mortgage insurance will also be required.
Related post: 15-Year vs 30-Year Mortgage: Which Is Right for You?
An FHA loan is a mortgage insured by the Federal Housing Administration (FHA). It is structured in much the same way as a conventional fixed-rate mortgage is, with some differences.
Whereas a conventional fixed-rate mortgage requires between a minimum down payment of 5%-20%, an FHA loan has a minimum down payment of 3.5% for those who qualify.
Also, credit score requirements are more relaxed with an FHA loan. You’ll need a minimum credit score of 500, though a score of about 580+ will likely qualify you for the lower down payment requirement. And, of course, the better the credit score, the better (lower) the mortgage interest rates will be.
If you are a qualified US veteran, currently active-duty military, or a surviving spouse, a VA loan may be worth considering. This is a mortgage that is given through a lender but insured by the Department of Veterans Affairs. You can check eligibility requirements.
For those that qualify, a VA loan has several advantages. The first is a lower credit score needed for qualifying for the loan, though ideally a score of 620 or greater is wanted. There is no mortgage insurance required, rates are typically lower than those for a conventional loan, and often times a down payment isn’t even required(!).
The downside, if it is one, is that while you won’t pay mortgage insurance there is a “funding fee.” This is a fee paid directly to the Department of Veterans Affairs. The fee currently ranges anywhere from 1.25%-3.3% of the loan amount, depending on down payment, type of military service, and if it is your first VA loan or not.
Adjustable-rate mortgages (ARMs) seem to become more popular when interest rates rise. Why? ARM loans start with a lower interest rate locked in for a period of five, seven, or 10 years before the interest rate then adjusts annually thereafter.
This means if you are young with less money, it may be easier to qualify for an ARM with its lower payments than it would be to qualify for the same size conventional loan. This type of mortgage can also work well for those that plan on selling the home before the lock-in period ends.
If interest rates go down, rather than up, the buyer with an ARM may save money in the long-run because of lower interest payments. However, if interest rates go up, buyers that have not moved or refinanced will face higher mortgage payments once the lock-in period has expired.
Combo or Piggyback mortgage
Another type of mortgage for buying a home, or rather, a combination of mortgages, is a piggyback loan.
It sounds strange, but this setup is basically two separate mortgages with the purpose of avoiding having to pay private mortgage insurance (PMI).
Conventional loans require a 20% down payment if you want to avoid having to pay PMI, and not everyone can come up with a 20% down payment.
To avoid paying PMI, a borrower needs to have a mortgage loan of no more than 80% of the home’s value or purchase price. So a combo or piggyback loan consists of a first mortgage and a second mortgage. The first mortgage is usually 80% of the purchase price and the second, or piggyback-mortgage, is often 10-20% of the purchase price, depending on how large a down payment the buyer provides.
Ok, you say, but then you are paying two mortgages and the interest on the second is usually higher. Yes, but often the payment on the two mortgages combined is less than that of a mortgage payment plus PMI.
So, it depends. You’ll want to sit down and do some math to see what makes sense for you.
Related post: How to Remove Your Private Mortgage Insurance
Interest only mortgage
Have you ever heard of an interest-only mortgage? It is pretty much how it sounds. The buyer takes out a mortgage loan and only makes interest payments for the first five or ten years. After that period, the buyer makes both principal AND interest payments, and the interest may vary. This means at that point, payments will become a lot higher.
This seems crazy. It was one of the schemes that got people in trouble before the 2008 meltdown. While these loans are still available, the requirements are, thankfully, a bit more stringent.
Why do people opt for this? Buyers may be tempted by the initially very low payments and hope that before the larger payments begin that they’ll be earning a lot more money or have refinanced before that point.
It sounds good in theory but doesn’t always work out. On the other hand, in some situations, it is a good choice.
Related post: Mortgage Pre-Approval: What You Need to Do
Choosing your mortgage
Selecting the best mortgage for you depends on your credit, budget, and how long you intend to remain in the home. Take time to talk to your lender and run the numbers so you are prepared when it is time to look for that dream home.