Many people dream about owning a home one day, but the homebuying process might seem intimidating and overwhelming. There are several steps you must take in order to purchase a home, and your financial situation will play an important role.
You’ve probably heard the term “mortgage,” but what does it mean? What is a mortgage, and what types of mortgages are available?
Learn more about mortgages, which types of mortgages exist and other types of home loans to consider if buying a home is in your future.
What is a Mortgage?
A home mortgage is a type of loan banks, mortgage companies and other financial institutions give to someone when they purchase a home. Home mortgages are only given for primary, secondary or investment residences — in other words, home mortgages do not apply to purchases of commercial or industrial properties.
In a mortgage, the homeowner is called the borrower, and the bank, company or financial institution is considered the lender. When purchasing a home, the borrower transfers the property title to the lender to hold until they can pay off the entirety of the loan. After the final loan payment is made and other mortgage conditions are met, the lender returns the property title to the borrower.
Mortgages are secured debts — the home is essentially a backing for the loan — meaning that mortgage interest rates are much lower than any other loan people can find. Keep in mind that if a borrower cannot make mortgage payments, the lender has a right to foreclose on the home and sell it on the open market.
If you’re considering buying a mortgage, remember — it’s crucial to read the fine print on all mortgage agreements before you sign to make sure you know what you’re agreeing to. If necessary, you can meet with an FHA-Approved counselor to learn more about your mortgage options and understand all of the nitty-gritty details.
5 Types of Mortgages for Homebuyers
Now that you know the basics of a home mortgage, continue reading and discover five types of mortgages consumers often choose for their unique financial situations.
All types of conventional mortgages fall into two categories — conforming and non-conforming — and are not backed by the federal government.
Conforming conventional loans abide by standards set forth by the Federal Housing Financing Agency (FHFA). These standards include credit, debit and loan size. In 2022, most conforming loan limits are $647,200, while expensive areas have a $970,800 limit.
Non-conforming loans, on the other hand, do not follow FHFA standards. These loans are best suited to borrowers who purchase more expensive homes or have unusual credit profiles. Conventional mortgages typically have lower borrowing costs, even if interest rates are slightly higher than other types of loans.
The two most common types of fixed-rate mortgages are 15 and 30-year loans. Some fixed-rate mortgage lenders allow borrowers to pick any loan term between eight and 30 years. Fixed-rate mortgages maintain the same interest rate during the life of the loan. In other words, your monthly payment will also remain the same.
It’s well-known that fixed-rate mortgages make budgeting easier for homeowners because they their monthly payment amount is the same each month. Unfortunately, if home interest rates fall, there is no way to adjust your fixed-rate mortgage to benefit from the lower rate. Additionally, interest rates for these loans are typically higher compared to other types of mortgages.
An adjustable-rate mortgage (ARM) is less stable than a fixed-rate mortgage because its interest rates are subject to market fluctuations. Many ARMs have fixed interest rates for a few years, but eventually, the loan term changes to a variable interest rate. This essentially means that you’ll likely pay the same amount in monthly payments for the first couple of years, but you could pay more or less in the future.
There is some risk involved with ARMs because you might not be able to make more expensive payments in the future. Additionally, the value of your home might decrease over time, making it more challenging to refinance or sell your home before the loan resets.
4. Jumbo Loan
A jumbo mortgage falls outside of the FHFA borrowing limits and are more common in expensive regions. For example, borrowers often receive loans in cities like Los Angeles, San Francisco and New York City. Homeowners in Hawaii may also receive jumbo loans.
These types of loans are helpful if you plan on buying an expensive residence. The interest rates on jumbo loans are often fairly competitive with those of conventional rates. There are specific criteria borrowers must meet in order to qualify for a jumbo loan. For example, you likely need a credit score above 700, put a 10-20% down payment and prove that you have significant assets in a cash or savings account.
The federal government is not considered a mortgage lender, but they make home ownership possible for many Americans. Essentially, government-insured mortgages are backed by three federal agencies:
- U.S. Department of Veteran Affairs (VA)
- U.S. Department of Agriculture (USDA)
- U.S. Federal Housing Administration (FHA)
For example, VA mortgages are available for active and veteran members of the U.S. military. USDA loans can help people purchase homes in rural, USDA-eligible regions. Lastly, borrowers can receive FHA loans if they cannot afford a down payment or have a low credit score.
Finding the Right Mortgage for Your Financial Circumstances
Every home loan borrower has unique financial circumstances that will inevitably affect which type of mortgage they need. The five types of mortgage outlined above are a handful of examples, as there are other types of loans such as piggyback, balloon and interest-only mortgages. Hopefully, you feel more knowledgeable about home mortgages so you can find the right type for your particular situation.