When you’re shopping for a home, you’ll be making many decisions, from the price of the house you can afford to the neighborhood you want to live in. Another important decision is the type and length of your mortgage.
There are several types of mortgages, each offering unique characteristics and benefits. The right type of home loan depends on your credit score, down payment, location and more.
When you work with a mortgage lender, they can do a deep dive into your personal finances and recommend a loan type that’s suitable for your situation.
This guide can serve as an entry point to explain the most common loan types, what’s required for approval and who each type of mortgage is best for.
What is a mortgage?
A mortgage is a financial agreement between a borrower and a lender, where the lender loans you money to buy a home based on an applied interest rate. As the borrower, you agree to repay the balance in monthly payments, which apply to both the principal loan balance and the accrued interest.
A mortgage is a type of secured loan, meaning it’s backed by collateral — in this case, the house itself. If you don’t repay the loan as promised, the lender has the right to seize the property in a process called foreclosure.
What is refinancing?
Refinancing is the process of replacing your current mortgage with a new one. You’ll take out an entirely new mortgage, with a new interest rate and loan term, which is used to pay off your old loan. Some of the most common reasons borrowers refinance their loans are to lower their interest rate or monthly payments. With a cash-out refinance, homeowners can borrow more than their original loan balance and receive the difference in cash.
What is a loan term?
Each mortgage has a loan term, which is the amount of time over which you’ll repay the balance. Mortgage payment schedules often range from 10 to 30 years, with 30-year terms being the most common.
Your loan term directly impacts your monthly payment. The longer your loan term, the lower your monthly payment. However, longer terms generally have higher interest rates, and because it takes longer to repay the loan, you’ll pay more interest in the long run.
What is an interest rate?
Another feature of each mortgage is an interest rate. Interest is what lenders charge in exchange for borrowing money. The higher your interest rate, the more expensive your monthly payment will be and the more you’ll pay for your loan.
Most mortgages have fixed interest rates, meaning you’ll pay the same rate for the entire loan term. However, there are also mortgages with adjustable rates that can change over time.
Mortgage interest rates fluctuate based on the economy and the rates set by the Federal Reserve.
What are the different types of loans?
Fixed-rate mortgages
A fixed-rate mortgage is the most common type of conventional home loan, where you’ll pay the same interest rate every month for the duration of the loan. The only time your interest rate will change is if you refinance your mortgage. Because your interest rate doesn’t change, the principal and interest portion of your monthly loan payment also remains stable.
Adjustable-rate mortgages
Adjustable-rate mortgages have a fixed interest rate for a set amount of time, after which the interest rate fluctuates periodically. For example, a 5/1 ARM means you’ll have a fixed interest rate for the first five years and then a variable interest rate that changes every year after that. ARMs usually start out lower than standard fixed-rate mortgages but can change over time based on a benchmark.
Jumbo loans
A jumbo loan is a mortgage that finances a property that’s too expensive for a traditional loan. Jumbo loans exceed the conforming loan limits, which vary depending on where you live. The qualifications for jumbo loans tend to be more strict. For most lenders, you’ll need a credit score of at least 700 and usually a 20% down payment. Jumbo loans can have fixed or adjustable rates.
Balloon mortgages
A balloon mortgage is a loan that has low or no monthly payments for a set amount of time and then eventually a large, lump-sum final payment (known as a balloon payment), usually after five or seven years. These types of loans are risky. You’ll owe a lot of money at the end of your loan, and if you can’t pay it off, you could lose your home. Balloon mortgages aren’t commonly used by traditional buyers, but are more popular among real estate investors and flippers.
What kinds of mortgages do I qualify for?
1. Conventional loan
What it is: A conventional loan is a loan that isn’t backed by a government agency. It is the most common type of loan. Conventional loans come in 10-, 15-, 20- and 30-year terms, with 30-year terms being the most popular option. Conventional loans can be either conforming or nonconforming loans.
What you need: You can get a conventional loan with as little as a 3% down payment and a 620 credit score. The lower your credit score, the more money you might need for a down payment. If your down payment is less than 20%, you’ll also be required to pay for private mortgage insurance until you reach 20% equity in your home.
Who it’s good for: The majority of home loans — around 75% — are conventional loans, so it’s good for most people. You can use it for your first home, second home and even investment properties.
Who should skip it: Borrowers who don’t meet the minimum credit score requirements.
2. FHA loan
What it is: An FHA loan is one that’s backed by the Federal Housing Administration. The FHA provides mortgage insurance to the private lenders who offer these loans, in case a borrower defaults. FHA loans can be administered by local banks, credit unions and online lenders and come in 15- and 30-year terms.
What you need: To secure the minimum 3.5% down payment available for FHA loans, your credit score will need to be 580 or above. If it’s between 500 and 580, you can still qualify, but you’ll need at least a 10% down payment. FHA loans also require a mortgage insurance premium, which protects the lender in case you default on your loan. Depending on your loan amount and down payment, MIP may last either 11 years or for the duration of your loan.
Who it’s good for: Borrowers who don’t have strong enough credit to qualify for a conventional loan.
Who should skip it: Borrowers who have good or excellent credit that would qualify you for a conventional loan.
Check out our full guide to FHA loans.
3. VA loan
What it is: VA loans are available to current and former military members who need certain service requirements. These loans are offered by private lenders and backed by the US Department of Veterans Affairs.
What you need: The Department of Veterans Affairs doesn’t set down payment or minimum credit score requirements for VA loans. However, individual lenders may set their own requirements. Additionally, the VA requires an upfront funding fee, which ranges from 1.25% to 3.3% and must be paid at the time of closing.
Who it’s good for: Those who serve or have served in the military and meet the service requirements set by the Department of Veterans Affairs.
Who should skip it: Borrowers who aren’t in the military. Also, VA loans are available only for primary residences, so if you need funding for a second home or investment property, you’ll need to look at other options.
Check out our full guide to VA loans.
4. USDA loans
What it is: USDA loans are backed by the US Department of Agriculture and offered by private lenders. They’re designed for low-income borrowers in rural areas, meaning they’re available only in designated areas throughout the U.S. You can check to see if you’d qualify by checking the eligibility site.
What you need: There’s no down payment required for a USDA loan. Though the USDA doesn’t set a minimum credit score, most lenders require at least a fair credit score. To qualify for a USDA loan, you must have a household income that’s no more than 115% of the median household income for your area. Finally, USDA lenders must pay a loan guarantee fee, which is usually passed along to the borrower.
Who it’s good for: Families in rural areas who meet the income and location restrictions.
Who should skip it: Borrowers who don’t meet the location and income requirements or who have sufficient credit to qualify for a conventional loan.
Check out our full guide to USDA loans.
How can I get the best deal on a mortgage?
A home is the most expensive purchase most of us will make in our lives, and interest can add hundreds of thousands of dollars to that cost. When shopping for a mortgage, it’s important to seek out the best deal possible to help reduce your upfront and ongoing monthly costs.
Here are a few key strategies to help you get the best deal on your mortgage:
- Boost your credit score: Your credit score is one of the most important factors lenders use to set mortgage rates. The higher your credit score, the better the rate you’ll qualify for. Increasing your credit score even just a little bit before you buy a home can save you a lot of money in the long run.
- Increase your down payment: Lenders often offer lower interest rates to borrowers who make larger down payments. Because you have more skin in the game, a lender will likely see you as a lower risk. Additionally, a larger down payment lowers your monthly payment since you have a smaller loan to repay.
- Pay mortgage points: Mortgage discount points are a tool lenders offer to help you lower your mortgage rate. You pay a lump sum upfront when you get your loan and in exchange, your lender will lower your rate.
- Lower your DTI: Your DTI, or debt-to-income ratio, represents the portion of your gross income you pay toward debt each month. Most mortgages have a maximum DTI. Not only can a lower DTI help you qualify for a loan, but it can also help you qualify for a lower interest rate.
- Shorten your loan term: Lenders generally offer lower interest rates on shorter loan terms. Though not everyone can choose a shorter loan term because of the significant increase in monthly payments, doing so will save you money on interest throughout your loan.
- Compare lenders: When applying for a mortgage, don’t just get one from the first lender you speak to. Instead, shop around and get rate quotes from multiple lenders to compare offers and choose the lender that offers you the best deal.
- Research buyer assistance: There are plenty of assistance programs for both first-time and repeat homebuyers, which can help you pay for your down payment, closing costs and more.
