When financing a home purchase, understanding the different types of mortgage loans available is crucial. The choices you make regarding loan type, term, and interest rate type will significantly impact your monthly payments, the total cost of your loan, and your long-term financial stability.
1. Loan Type: Conventional, Government, or Special Program
Mortgage loans are categorized based on loan size and whether they are part of a government program. This choice influences your required down payment, the total cost (including interest and mortgage insurance), and your borrowing capacity.
- Conventional Loans:
- Description: These are the most common type of mortgage loans and are not insured or guaranteed by a government entity. They are typically offered by private lenders.
- Characteristics:
- Generally require higher credit scores and a lower debt-to-income ratio compared to FHA loans.
- Can offer competitive interest rates if you have good credit and a substantial down payment.
- Often cost less overall than FHA loans in the long run due to lower mortgage insurance premiums (or no mortgage insurance if you put down 20% or more).
- Can be conforming (meeting Fannie Mae and Freddie Mac guidelines for loan limits) or non-conforming (jumbo loans, exceeding these limits).
- Government Loans: These programs are designed to make homeownership more accessible to specific groups or in certain areas.
- FHA Loans:
- Description: Insured by the Federal Housing Administration (FHA), these loans are originated by private lenders but backed by the government.
- Characteristics:
- Allow for down payments as low as 3.5%.
- More flexible credit score requirements, making them accessible to borrowers with lower credit scores.
- Have specific loan limits that vary by county.
- Typically require both an upfront mortgage insurance premium and annual mortgage insurance premiums, which can make them more expensive than conventional loans for borrowers with good credit and larger down payments.
- VA Loans:
- Description: Guaranteed by the Department of Veterans Affairs (VA), these loans are for eligible veterans, active-duty service members, and surviving spouses.
- Characteristics:
- Often require no down payment.
- No private mortgage insurance (PMI) is required.
- Competitive interest rates.
- May include a VA funding fee, which can be financed into the loan.
- Not all lenders participate in the VA loan program.
- USDA Loans:
- Description: Guaranteed by the U.S. Department of Agriculture (USDA), these loans are designed for low- to middle-income borrowers in eligible rural and some suburban areas.
- Characteristics:
- Often require no down payment.
- Income limits apply based on the median income for the area.
- The property must be in a USDA-approved rural area.
- Designed to promote development in rural communities.
- FHA Loans:
- Special Programs:
- State or Local Housing Agencies (HFAs):
- Description: These programs are offered by state or local Housing Finance Agencies to assist specific groups, such as low- to moderate-income borrowers, first-time homebuyers, or public service employees (teachers, police officers).
- Characteristics:
- Often provide low-interest-rate mortgages, low down payment options, and down payment or closing cost assistance.
- May include Mortgage Tax Credit Certificates (MCCs) which offer a dollar-for-dollar federal tax credit.
- Vary significantly by state and locality.
- Special Purpose Credit Programs (SPCPs):
- Description: These are targeted lending products from private lenders or non-profit organizations designed to benefit economically disadvantaged groups or address specific social needs, often in targeted communities.
- Characteristics:
- Explicitly permitted by the Equal Credit Opportunity Act (ECOA) to overcome historical barriers to credit access for certain populations.
- May allow lenders to consider factors like race or ethnicity if the program is designed to expand credit access to a class of persons who would otherwise be denied credit or receive it on less favorable terms.
- State or Local Housing Agencies (HFAs):
What to Know: Each loan type serves a different purpose. It’s essential to understand which options you qualify for and to get multiple quotes to compare costs, especially through official “Loan Estimates.”
2. Loan Term: 30 Years, 15 Years, or Other
The loan term is the duration over which you will repay your mortgage. This choice significantly impacts your monthly principal and interest payment, your interest rate, and the total interest paid.
| Feature | Shorter Term (e.g., 15-year) | Longer Term (e.g., 30-year) |
| Monthly Payments | 🔴 Higher | 🟢 Lower |
| Interest Rate | 🟢 Typically Lower | 🔴 Typically Higher |
| Total Cost | 🟢 Lower (less interest paid) | 🔴 Higher (more interest paid) |
What to Know: Shorter terms generally save you money overall because you pay interest for a shorter period, and lenders typically offer lower interest rates for less risk. However, the higher monthly payments can make them less affordable for some budgets. Always compare “Loan Estimates” for different terms to see the exact costs and ensure it fits your financial situation.
3. Interest Rate Type: Fixed Rate or Adjustable Rate
The interest rate type determines whether your interest rate and monthly principal and interest payment will change over time.
| Feature | Fixed Rate | Adjustable Rate (ARM) |
| Risk Level | 🟢 Lower risk, no surprises | 🔴 Higher risk, uncertainty |
| Initial Interest Rate | 🔴 Higher | 🟢 Lower to start |
| Rate Changes | Rate does not change | After initial fixed period, rate can increase or decrease |
| Monthly Principal & Interest Payments | Stay the same | Can increase or decrease over time |
| Borrower Preference (2008–2022) | Chosen by 85-95% of buyers | Chosen by 5-15% of buyers |
| Borrower Preference (Historically) | Chosen by 70-75% of buyers | Chosen by 25-30% of buyers |
What to Know:
- Fixed-Rate Mortgages: Offer stability and predictability, as your principal and interest payment remains constant. This is ideal if you value long-term certainty about housing costs. While your total monthly payment can still change (due to fluctuating property taxes, homeowner’s insurance, or mortgage insurance), the core principal and interest portion remains stable.
- Adjustable-Rate Mortgages (ARMs): Offer lower initial interest rates and payments for an introductory fixed period (e.g., 5, 7, or 10 years). After this, the rate adjusts regularly based on market conditions and an index.
- Risk: Payments can significantly increase, potentially even double, if market rates rise.
- Rate Caps: Most ARMs include caps that limit how much the interest rate can change during each adjustment period and over the life of the loan.
- Consideration: ARMs can be suitable if you plan to move or refinance before the fixed-rate period ends. However, if you stay in the home longer than expected, you could face much higher payments. It’s crucial to understand how ARM rates change and review the “Consumer Handbook on Adjustable-Rate Mortgages.”
Avoiding Pitfalls and Risky Features
When reviewing loan offers, be vigilant for features that could create future financial surprises:
- Prepayment Penalty: A fee charged by some lenders if you pay off all or a significant portion of your mortgage early, typically within the first few years of the loan.
- Balloon Payment: A mortgage structure where low or interest-only payments are made for an initial period, followed by a large, lump-sum payment of the remaining principal at the end of the loan term. If you cannot make this payment, you could face foreclosure.
- Negative Amortization: Occurs when your monthly payment is less than the interest accrued. The unpaid interest is added to your principal balance, causing the amount you owe to increase over time, even as you make payments. This can lead to owing more than your home is worth.
- Interest-Only Loan: For a specified period, your scheduled payments only cover the interest on the loan, not the principal. After this period, your payments will significantly increase as you begin to pay down the principal.
If your loan includes any of these features, ask the loan officer for a clear explanation of why they are included and their implications. Request a “Loan Estimate” for a similar loan without these features to compare costs and understand the added risk.
Government Regulation and Qualified Mortgages
Mortgage loans are subject to government regulations designed to protect consumers. Lenders are generally required to document and verify your income, employment, assets, debts, and credit history to assess your ability to repay the loan. If a loan meets certain criteria after this verification, it may be classified as a “qualified mortgage.”
“Nonqualified mortgages” are loans that don’t meet these criteria, often because they have unique characteristics that make them riskier or more expensive. These can sometimes be marketed to self-employed borrowers or those without Social Security numbers. It’s essential to understand the implications if you are offered a nonqualified mortgage.
Always consult with multiple lenders and consider speaking with a HUD-certified housing counselor to ensure you choose the mortgage option that best aligns with your long-term homeownership goals and financial situation.