Ready to purchase a home? Learn everything you will need about home loans, different types of mortgages, and how they differ from other government-insured loan options.
What Is a Mortgage?
When it comes to purchasing a home, most people rely on mortgages to finance this significant investment. But what exactly is a mortgage? Simply put, a mortgage is a loan that is used to buy a property. The borrower agrees to pay back the loan, plus interest, over a specified period of time. In return, the lender holds the property as collateral until the loan is fully repaid.
The 6 Main Types of Mortgages
Conventional Mortgages
A conventional mortgage is a type of home loan that is not insured or guaranteed by the government. These mortgages typically require a higher down payment compared to other types of loans, such as FHA or VA loans. However, they offer more flexibility in terms of loan terms and interest rates.
One advantage of a conventional mortgage is that it allows borrowers to choose from a wide range of lenders, including banks, credit unions, and mortgage companies. This gives borrowers the opportunity to shop around and compare different loan options to find the best fit for their financial situation.
It’s important to note that conventional mortgages have stricter qualification requirements compared to government-backed loans. Borrowers typically need a good credit score, stable employment history, and a low debt-to-income ratio to be eligible for a conventional mortgage.
Conforming Mortgage Loans
Conforming mortgage loans are a specific type of conventional mortgage that meets the guidelines set by government-sponsored enterprises, such as Fannie Mae and Freddie Mac. These guidelines include loan limits, credit score requirements, and underwriting standards.
One of the main advantages of a conforming mortgage loan is that it allows borrowers to take advantage of lower interest rates compared to non-conforming loans. This is because conforming loans are considered less risky for lenders, as they adhere to the standardized guidelines set by government-sponsored enterprises.
To qualify for a conforming mortgage loan, borrowers must meet certain criteria, such as having a good credit score, a stable income, and a low debt-to-income ratio. Additionally, the loan amount must fall within the maximum limits set by the government-sponsored enterprises.
Non-conforming Mortgage Loans
Non-conforming mortgage loans, also known as jumbo loans, are loans that exceed the loan limits set by government-sponsored enterprises. These loans are typically used to finance higher-priced properties or homes in areas with high real estate values.
One advantage of non-conforming mortgage loans is that they allow borrowers to finance larger loan amounts. This can be beneficial for individuals looking to purchase luxury homes or properties in expensive markets.
However, non-conforming loans often come with higher interest rates and stricter qualification requirements compared to conforming loans. Borrowers may need a higher credit score, a larger down payment, and a lower debt-to-income ratio to be eligible for a non-conforming mortgage loan.
Government-Insured Federal Housing Administration (FHA) Loans
One option to consider is a government-insured Federal Housing Administration (FHA) loan. These loans are designed to help individuals with a lower credit score or a smaller down payment. The FHA loan program offers flexible qualification criteria and competitive interest rates.
With an FHA loan, the government insures the loan, which means that lenders are more willing to offer loans to borrowers with less-than-perfect credit. This can be particularly beneficial for first-time homebuyers who may not have a long credit history. Additionally, FHA loans typically require a lower down payment compared to conventional mortgages.
However, it’s important to note that FHA loans do come with certain requirements. For instance, borrowers are required to pay mortgage insurance premiums which can increase the overall cost of the loan. It’s also important to carefully review the terms and conditions of an FHA loan before making a decision.
Government-Insured Veterans Affairs (VA) Loans
Another type of government-insured loan is the Veterans Affairs (VA) loan. These loans are available to veterans, active-duty service members, and eligible surviving spouses. VA loans offer several advantages, including no down payment requirement and no private mortgage insurance (PMI) requirement.
VA loans are backed by the Department of Veterans Affairs, which means lenders have more confidence in offering loans to eligible borrowers. Additionally, VA loans often come with competitive interest rates and flexible qualification criteria. This can be a great option for those who have served in the military.
To qualify for a VA loan, borrowers must meet certain eligibility requirements, including a minimum length of service. It’s important to work with a knowledgeable VA lender to navigate the application process and ensure all requirements are met.
Government-Insured U.S. Department of Agriculture (USDA) Loans
The U.S. Department of Agriculture (USDA) offers government-insured loans for individuals in rural areas. These loans are designed to promote homeownership in rural communities by providing affordable financing options. USDA loans offer 100% financing, meaning no down payment is required.
To qualify for a USDA loan, borrowers must meet income requirements and the property must be located in an eligible rural area. USDA loans typically have competitive interest rates and flexible credit guidelines, making them an attractive option for those who meet the criteria.
It’s important to note that USDA loans have certain restrictions, such as income limits and property location requirements. Working with a knowledgeable USDA lender can help ensure a smooth application process and help determine eligibility.
Types of Interest Rates
Fixed Interest Rate
A fixed interest rate mortgage offers stability and predictability. With this type of mortgage, the interest rate remains the same throughout the duration of the loan, regardless of fluctuations in the market. This means your monthly mortgage payments will also remain constant, providing you with peace of mind and allowing for better budgeting. Fixed interest rates are ideal for individuals who prefer stability and want to lock in a specific interest rate for an extended period.
Variable Interest Rate
Unlike a fixed interest rate, a variable interest rate mortgage is subject to market fluctuations. This means that your interest rate and monthly mortgage payments can increase or decrease over time. Variable interest rates are typically tied to a benchmark, such as the prime rate, and can vary based on changes in the economy. While variable interest rates may offer lower initial rates compared to fixed interest rates, they come with the risk of potential increases in the future. Individuals who are comfortable with some level of uncertainty and are looking for potential cost savings may opt for a variable interest rate mortgage.
Partially-Fixed Rate
A partially-fixed rate mortgage combines the advantages of both fixed and variable interest rates. With this type of mortgage, a portion of the loan is fixed while the remaining portion is variable. This allows borrowers to benefit from the stability of a fixed interest rate while also taking advantage of potential savings from a variable interest rate. Partially-fixed rate mortgages provide flexibility and can be tailored to individual preferences and risk tolerance.
5 Features To Look For In A Mortgage
When choosing a mortgage, it’s important to consider the features that best align with your financial goals and lifestyle. Here are five key features to look for:
1. Extra Repayments
The ability to make extra repayments on your mortgage can significantly reduce your overall interest payments and shorten the loan term. Look for a mortgage that allows you to make additional payments without penalties or restrictions. Being able to contribute more towards your mortgage when you have surplus funds, such as a bonus or inheritance, can help you become debt-free faster.
2. Redraw Facility
A redraw facility allows you to access any additional funds you’ve paid into your mortgage. This can be beneficial in situations where you need extra cash for unexpected expenses or investment opportunities. It’s important to review the terms and conditions of the redraw facility, as some mortgages may have restrictions or fees associated with accessing these funds.
3. Repayment Holidays
Life is full of unexpected events, and having the option to take a repayment holiday can provide financial flexibility during challenging times. A repayment holiday allows you to temporarily suspend your mortgage repayments for a specified period without being penalized. This feature can be particularly helpful during maternity leave, career changes, or other circumstances where your income may be reduced temporarily.
4. Interest Only
An interest-only mortgage allows you to make lower monthly payments by only paying the interest portion of the loan for a certain period. This can be advantageous for individuals who are looking to maximize cash flow or have other investment opportunities. However, it’s important to understand that during the interest-only period, you’re not reducing the principal balance of the loan, which means your monthly payments will increase once the interest-only period ends.
5. Mortgage Offset Accounts
A mortgage offset account is a savings or transaction account that is linked to your mortgage. The funds in this account are offset against your outstanding loan balance, reducing the amount of interest you pay. For example, if you have a mortgage of $300,000 and $50,000 in your offset account, you’ll only be charged interest on $250,000. This feature can help you save on interest costs and potentially pay off your mortgage faster.
