Overview of Types of Mortgages Available There are many different types of mortgages available to home buyers. They are all thoroughly explained here. But here, for the sake of simplicity, we have boiled it all down to the following options and categories. Option 1: Fixed vs. Adjustable Rate As a borrower, one of your first choices is whether you want a fixed- rate or an adjustable- rate mortgage loan. All loans fit into one of these two categories, or a combination "hybrid" category. Here's the primary difference between the two types: Fixed- rate mortgage loans have the same interest rate for the entire repayment term. Because of this, the size of your monthly payment will stay the same, month after month, and year after year. It will never change. This is true even for long- term financing options, such as the 30- year fixed- rate loan. It has the same interest rate, and the same monthly payment, for the entire term. Adjustable- rate mortgage loans (ARMs) have an interest rate that will change or "adjust" from time to time. Typically, the rate on an ARM will change every year after an initial period of remaining fixed. It is therefore referred to as a "hybrid" product. A hybrid ARM loan is one that starts off with a fixed or unchanging interest rate, before switching over to an adjustable rate. For instance, the 5/1 ARM loan, carries a fixed rate of interest for the first five years, after which it begins to adjust every one year, or annually. That's what the 5 and the 1 signify in the name. Pros and cons: adjustable versus fixed- rate m ortgages As you might imagine, both of these types of mortgages have certain pros and cons associated with them. Use the link above for a side- by- side comparison of these pros and cons. Here they are in a nutshell: The ARM loan starts off with a lower rate than the fixed type of loan, but it has the uncertainty of adjustments later on. With an adjustable mortgage product, the rate and monthly payments can rise over time. The primary benefit of a fixed loan is that the rate and monthly payments never change. But you will pay for that stability through higher interest charges, when compared to the initial rate of an ARM. Option 2: Governm ent- Insured vs. Conventional Loans So, you'll have to choose between a fixed and adjustable- rate type of mortgage, as explained in the previous section. But there are other choices as well. You'll also have to decide whether you want to use a government- insured home loan (such as FHA or VA), or a conventional "regular" type of loan. The differences between these two mortgage types are covered below. A conventional home loan is one that is not insured or guaranteed by the federal government in any way. This distinguishes it from the three government- backed mortgage types explained below (FHA, VA and USDA). Government- insured home loans include the following:
FHA Loans The Federal Housing Administration (FHA) mortgage insurance program is managed by the Department of Housing and Urban Development (HUD), which is a department of the federal government. FHA loans are available to all types of borrowers, not just first- time buyers. The government insures the lender against losses that might result from borrower default. Advantage: This program allows you to make a down payment as low as 3.5% of the purchase price. Disadvantage: You'll have to pay for mortgage insurance, which will increase the size of your monthly payments. Pros and cons: FHA vs. conventional loans Nearly every home buyer will reach a point where they must choose between FHA loans and conventional mortgage loans. It's a big decision that should not be taken lightly. In this article, I'll share my own FHA vs. conventional experience with you. We spent a lot of time researching this subject when we bought a house a few years ago. So, you can benefit from the knowledge we gained. The benefits of using an FHA loan include: 1. Smaller down payment. If you use a conventional mortgage loan, you'll probably have to put at least 10% down. Some lenders are still willing to allow down payments as small as 5%. But with an FHA home loan, you could put down as little as 3.5% of the purchase price. The only way to put down less is by using the VA or USDA loan programs, but those are limited to certain types of borrowers. This was a big attraction for us when we bought a home in San Diego. We actually saved up enough money to make a larger down payment. But a 10% down payment would have seriously limited our buying power. So, we ended up choosing the FHA program to reduce our down- payment expense. This is a common strategy for first- time buyers in particular, because they often lack the money needed for larger down payments. When we were choosing between FHA and conventional mortgage loans, the down payment was the biggest factor. 2. Easier approval than conventional loans. It's generally easier to get approved for an FHA loan, as compared to a conventional mortgage. This is especially true in 2017. If you put down less than 20% on your loan, you'll be required to have private mortgage insurance or PMI (as explained in the ensuing pages look for The Extra Cost of Mortgage Insurance - PMI. With a conventional mortgage, the insurance comes from a private company - - not from the federal government, as with FHA loans. These insurance providers took huge losses during the foreclosure crisis that began in 2008 (and is still ongoing). As a result, PMI companies are fairly strict about the loans they will approve. If you were to use a conventional mortgage loan with less than 20% down, you would essentially have to be approved by two different companies. You need to get approved by the lender as well as the PMI provider. These insurance providers often require higher credit scores than the lenders themselves. They won't back any loans if there is the slightest amount of risk from the borrower. So, if your credit score is below 700 or so, you might have trouble getting a green light from the PMI company. When this happens, it doesn't matter what the lender says. You can be approved by the lender but denied by the mortgage insurance provider. But with an FHA home loan, the mortgage insurance comes from the federal government. And they are less strict about the types of borrowers they are willing to ensure. In fact, the FHA allows credit scores as
low as 500. (Just realize that some lenders will require credit scores of 620 or higher, even though the FHA's guidelines allow a score as low as 500. This is referred to as an overlay.) Still, when you compare conventional mortgages versus FHA loans, the qualification process is almost always easier on the FHA side. 3. More flexible guidelines for credit scores. I touched on this one above, but I want to expand on it. If you have a credit score below 640, you may have a hard time getting approved for a conventional mortgage loan in 2017. This is the baseline requirement used by the most lenders. But, as we talked about earlier, the PMI company might require an even higher credit score. This is another benefit of using an FHA loan to buy a house. You can get approved with a lower credit score. The FHA requires a score of 500 or higher for basic qualification. If you want to benefit from the 3.5% down- payment option, you will need a score of 580 or higher. Some lenders have actually lowered their credit requirements to match those set by the FHA. Credit scores weren't an issue for us when we bought our home. My wife and I both had credit scores over 750. In this range, we could've qualified for either an FHA loan or a conventional mortgage. But I know a lot of people don't have scores that high. The lower requirement on the FHA side could be a deciding factor for these folks. At any rate, it needed to be mentioned in this discussion. 4. Higher allowance for DTI. When you apply for a home loan, the lender will review your debt- to- income ratio or DTI. This is a comparison between the amount of money you earn each month, and the amount you pay toward your debts. A higher DTI can hurt your chances of getting approved for a loan. It can also reduce your buying power. This is another key consideration when looking at FHA loans versus conventional mortgages. With an FHA loan, it's possible to get approved with a debt- to- income ratio higher than 50%. It might not be wise to take on a mortgage loan with that much debt. But it is possible through the FHA program. I know people who have been approved for FHA loans with DTI ratios as high as 58%. This would never work for a conventional mortgage loan. For conventional, the debt- to- income ratio is usually capped at 45%. The DTI factor wasn't a big issue for us. Our ratio was in the high 30s, so we probably could've been approved for either conventional or FHA. I just wanted to mention it in this section, because it can be a deciding factor for mortgage approval. As you weigh your options between FHA loans and conventional mortgages, you need to consider the debt factor. And when I talk about "debts" in this context, I am referring to your car payment, credit card debt, student loans, etc. In other words, anything that shows up on your credit reports. 5. More forgiving of bankruptcy and foreclosure. If you've had a bankruptcy filing or a home foreclosure in the past, you may find it easier to qualify for an FHA loan. Most conventional mortgage loans end up being purchased by either Fannie Mae or Freddie Mac. These organizations have rules regarding borrowers with a foreclosure or bankruptcy on the record. The FHA has rules about this as well, but they are more lenient. It's possible to qualify for an FHA home loan within one or two years of a bankruptcy or foreclosure. You would probably have to wait a little longer for a conventional mortgage with either of these things in your past.
It's Not a Free Pass for Reckless Borrowers I'd like to point out that the FHA program is not a free pass for irresponsible borrowers. While it's usually easier to qualify for an FHA versus a conventional mortgage, you still need to have your finances in order. Over the last few years, the Federal Housing Administration has tightened up its lending requirements. They are requiring borrowers to have higher credit scores and larger down payments than in the past. If you decide to use this mortgage option, you can be sure the lender will review every aspect of your financial situation. They will check your credit score to ensure it meets the FHA's minimum guidelines. They might even impose their own higher guidelines on top of those required by the FHA. They will check your employment history to make sure you've been gainfully employed for the last couple of years. They will consider the amount of debt you have in relation to the amount of money you make. And, of course, there are certain loan limits for the amount of money you can borrow. I wanted to point all of this out, because there was a notion in the past that anyone could qualify for an FHA loan. But that is simply not the case today. Option 3: Jumbo vs. Conforming Loan There is another distinction that needs to be made, and it's based on the size of the loan. Depending on the amount you are trying to borrow, you might fall into either the jumbo or conforming category. Here's the difference between these two mortgage types. A conforming loan is one that meets the underwriting guidelines of Fannie Mae or Freddie Mac, particularly where size is concerned. Fannie and Freddie are the two government - controlled corporations that purchase and sell mortgage- backed securities (MBS). Simply put, they buy loans from the lenders who generate them, and then sell them to investors via Wall Street. A conforming loan falls within their maximum size limits, and otherwise "conforms" to pre- established criteria. A jumbo loan, on the other hand, exceeds the conforming loan limits established by Fannie Mae and Freddie Mac. This type of mortgage represents a higher risk for the lender, mainly due to its size. As a result, jumbo borrowers typically must have excellent credit and larger down payments, when compared to conforming loans. Interest rates are generally higher with the jumbo products, as well. This page explains the different types of mortgage loans available in 2017. But it only provides a brief overview of each type. Follow the hyperlinks provided above to learn more about each option. We also encourage you to continue your research beyond this website. Education is the key to making smart decisions, as a home buyer or mortgage shopper. The Conventional Mortgage Loan A conventional loan is one that is not insured by a government entity. These loans are made entirely in the private sector, without any government approval whatsoever. The primary benefit of using a conventional loan is that you can avoid mortgage insurance entirely. If you make a down payment of 20% or more, you won't have to pay for mortgage insurance. But if you put down less than 20%, you'll have to pay for PMI. This would increase the size of your monthly payment by $60 - $90 (on average).
If you can afford a down payment of 20% or more, the conventional versus FHA question is sort of a no- brainer. In this scenario, it would be best to use a conventional mortgage loan so you could avoid the extra insurance cost. People with smaller down payments have a tougher decision to make. For example, if you can only put 10% down for a conventional loan, you will probably be required to pay for PMI. The question is - - how does this cost compare to the extra mortgage insurance you would pay on an FHA loan? In most cases, the cost of PMI is much less than the insurance you would have to pay for an FHA loan. But then there's the down payment consideration. The FHA program offers a down payment as low as 3.5% for qualified borrowers. Government vs. Private Mortgage Insurance It really comes down to insurance costs and down payments. If you can afford to put 20% down on your loan, you'll have an easier time choosing a type of loan. It makes sense to use a conventional mortgage loan in that scenario, because you wouldn't face any type of mortgage insurance at all. But once you get below the 20% mark, the FHA loan starts to look pretty darn good. With a down payment of less than 20%, you're going to pay mortgage insurance in some form - - whether it comes from the government or from a private insurer. Then it's just becomes a matter of priorities. What's Your Biggest Priority? At this point, you have to ask yourself what's more important to you: Do I want to make the larger down payment of 10% on a conventional loan, and pay a smaller amount of mortgage insurance each month? Or... do I want to make a smaller down payment of 3.5% for an FHA loan, and pay more in mortgage insurance every month? Answer these questions, and you'll know which type of loan is right for you. You can see it's a trade- off either way. This is a question you must answer for yourself. Your lender cannot do it for you. As for my wife and I, we chose the smaller down payment allowable under the FHA program. This resulted in a slightly higher mortgage payment each month, because the FHA insurance costs are higher than private mortgage insurance. But we increased our buying power by reducing the down payment requirement. In California, it's almost impossible to find a conventional mortgage with a down payment of 5%. Most lenders in the state are requiring at least 10% down. So, for us, the difference between 3.5% and 10% was the primary deciding factor. This article explains the pros and cons of conventional versus FHA home loans. If you would like to learn more about any of the topics discussed in this article, use the search box at the top of this page. You'll find a wealth of information on this site! What happens if you put down less than 20% when buying a home? The short answer is that you will probably have to pay for private mortgage insurance, if you put less than 20% down on a home purchase. There are ways to avoid this added cost, and we will discuss those strategies in a moment. But for now, just know that you might encounter an additional cost in the form of mortgage insurance.
Putting Down Less Than 20% on a Home Purchase Home buyers are not required to put down 20% when buying a house. This is a common misconception. The truth is you could possibly get a conventional home loan with a down payment as low as 3%. The FHA loan program offers 96.5% financing, with an investment of just 3.5%. Also, there are some credit union programs out there that offer 100% financing. So you don t necessarily have to make a down payment of 20% on a home purchase. With that being said, many home buyers do choose to make a down payment of 20%, and there is a very specific reason for this. They do it to avoid having to pay for mortgage insurance. The Extra Cost of Mortgage Insurance - PMI When a home loan accounts for more than 80% of the property value, mortgage insurance is typically required.. In other words, if the loan- to- value (LTV) ratio rises above 80%, it triggers the insurance requirement. Like it or not, this is just an industry standard. So, if you put less than 20% down on a home purchase, you might have to pay the extra cost of mortgage insurance. So, how much does it cost? On average, private mortgage insurance (PMI) ranges between $40 and $80 per month, for every $100,000 borrowed. For example, on a $200,000 home loan, a PMI policy might cost anywhere from $80 $160 per month. The cost tends to go up with the size of the home loan. Everything we just talked about applies to conventional home loans that are not insured by the government. Government- backed mortgage programs, like the popular FHA home loan, can also have this extra insurance. In fact, FHA loans require two kinds of mortgage insurance for home buyers. There s an upfront premium equal to 1.75% of the loan amount. There s also an annual premium that comes to 0.85% of the amount borrowed, for most borrowers. The bottom line is that if you put less than 20% down on a home purchase, you might trigger the mortgage insurance requirements mentioned above. And that could result in a higher monthly payment, while also increasing the overall cost of your loan. (You might also end up with a higher rate, as a result of making a smaller investment.) But mortgage insurance isn t all bad. Without it, a lot of people simply would not be able to purchase a house. Or they would have to wait a lot longer in order to save up a larger down payment. So, PMI is basically a way to extend mortgage financing to a larger number of home buyers, while reducing risk for mortgage lenders and investors. It offers a path to home financing for those who cannot afford a larger down payment. This article answers the question: What happens if you put less than 20% down on a home purchase? If you would like to learn more about this topic, follow the hyperlinks spread throughout the article. Our
website offers hundreds of articles and tutorials for homebuyers, and many of them have to do with down payments and mortgage insurance (PMI). VA Loans The U.S. Department of Veterans Affairs (VA) offers a loan program to military service members and their families. Similar to the FHA program, these types of mortgages are guaranteed by the federal government. This means the VA will reimburse the lender for any losses that may result from borrower default. The primary advantage of this program (and it's a big one) is that borrowers can receive 100% financing for the purchase of a home. That means no down payment whatsoever. For VA loan eligibility and requirements consult our lender. Reverse Mortgage: In general, to be eligible for a reverse mortgage the youngest borrower on title must be 62 years old or older and have sufficient home equity. You must also meet financial eligibility criteria as established by HUD. Determining whether or not there is sufficient equity in the home is an FHA calculation that takes into account: Current interest rate Whether the rate will be variable or fixed Age of the youngest homeowner FHA lending limits Appraised value of the home You may need to set aside additional funds from loan proceeds to pay for taxes and insurance. You can consult a Mortgage professional to find out if you have sufficient equity and what the loan principal limit would be.
Frequently asked questions for reverse mortgages: If a homeowner is not 62 but they are permanently disabled, can they qualify? No. The FHA use age as a criteria to determine reverse mortgage eligibility and makes no exceptions for disability or Social Security status. Can someone qualify if they have a mortgage? Yes, as long as they have sufficient equity. Many homeowners who take out a reverse mortgage use it to pay off their existing mortgage, so they can stop making monthly mortgage payments. 1 Do all 62- year olds who own their home qualify? No. Some homeowners who want to get a reverse mortgage are not eligible because they don t have enough equity built up in their home. In addition, some types of homes are not eligible and the borrower must also meet financial eligibility criteria as established by HUD. What happens if there isn t enough home equity to qualify? This is called a shortfall. This means that the reverse mortgage would not provide enough money to pay off the existing mortgage on the home it is coming up short. In this situation, some homeowners may choose to make up the difference by paying down the balance on their mortgage by the amount of the shortfall so that they can qualify for the reverse mortgage. However, most people who want a reverse mortgage and have a shortfall don t have enough money to do this.