In a housing market experiencing the highest interest rates in more than two decades, knowing the types of mortgages available to you before applying may be the key to punching a ticket to homeownership.
Learning a little about mortgage types can help you take advantage of the unique credit benefits you deserve. This could lower your interest rate and give you some breathing room on your monthly payment, or it could be your best shot at getting a new address.
Read more: How to get a mortgage in 2023
Mortgage loan types
It is the most common among all mortgage loans. A conventional mortgage is not backed by any government agency, but loans are originated to Fannie Mae or Freddie Mac specifications. Although they appear to be federal agencies, Fannie and Freddie are private companies authorized by the government to invest money in the mortgage system.
However, while these mainstream mortgages are the path to homeownership for many borrowers, they require a good credit score, a credit score no lower than 620, and enough cash for at least a 3% down payment and additional savings to pay closing costs.
Higher priced homes require larger mortgages. By 2023, the minimum home value for a jumbo loan in most of the country will be $726,200. In Alaska, Guam, Hawaii and the US Virgin Islands, the minimum is $1,089,300.
Jumbo loans are generally best suited for highly qualified mortgage applicants. Many lenders will look for a down payment of at least 10%, and some prefer 20% or more. A credit score approaching 700 or higher will also likely be a requirement.
Loans backed by the Federal Housing Administration are especially suitable for low- and moderate-income borrowers. FHA loans offer lower down payments and lower qualified credit scores. This may be the only way some Americans can put their name on a house. And although default rates have been historically low, the late payment rate for FHA loans has recently been three times higher than conventional mortgages.
If you’re living on the edge financially, it might be a good idea to increase your cash reserves and credit score before buying a home.
Backed by the Department of Veterans Affairs, VA loans are a valuable benefit for service members, veterans and eligible spouses. VA loans, which generally require no down payment, remove a major hurdle for millions of eager homebuyers.
But with the lowest supply of homes on the market in years, you may be competing with cash-out conventional loan buyers who court home sellers with larger earnest money deposits and a willingness to waive the closing costs the seller pays.
USDA loans, offered by the U.S. Department of Agriculture, are especially suitable for low-income borrowers in rural and agricultural areas.
Yes, this is another zero down payment option, but to qualify, your household can’t earn more than the family income limit for where you’re buying and the property must be in an eligible area.
Adjustable rate mortgage
Most borrowers first think about fixed-rate mortgages, where your interest rate is set from the beginning and never changes. Given higher interest rates and more expensive homes, it’s worth at least considering an adjustable-rate mortgage.
With an ARM, your annual percentage rate is fixed for a few years (say, the first five, seven, or even 10 years), and then the interest you pay adjusts every six months or annually. ARMs come in many different forms.
Read more: Credit score required to buy a house
The repayment period of a mortgage is known as the term. The 30-year mortgage term is traditionally the most popular; However, 15-year terms save a lot of interest, but the monthly payments are higher. Mortgage maturities can be 10, 20 and 25 years.
The FHA even introduced a 40-year mortgage to provide an option for homeowners struggling to meet payments.
Read more: Down payment required to buy a house in 2023
Other mortgage options
Assumable mortgages have declined over the years, but have become increasingly popular in subprime environments. In effect, the homeowner who carries the existing mortgage (presumably with a low interest rate) agrees to let the buyer assume the remaining mortgage balance and make payments going forward.
Possible hitch in the transaction: The existing mortgage lender must approve the buyer taking over the loan balance.
The buyer usually offers the seller a down payment to cover the home’s equity and perhaps profit. Sometimes this requires the buyer to apply for a separate loan.
Fly: Not all mortgages can be assumed. While government-backed loans such as FHA, VA and USDA loans are eligible, most conventional loans are not.
Interest-only mortgages delay paying off the principal for several years, temporarily reducing your payment. After the introductory period, your payment becomes higher and is split between principal and interest, just like with typical mortgage loans.
Fly: Interest-only mortgages can be risky, especially if the value of your home decreases. You may have trouble refinancing the loan, selling the home, or affording your higher monthly payment.