Understanding the different types of home loans available to you is essential for making an informed decision about one of the biggest financial commitments of your life.
Most home buyers will have to take out a home loan to cover the cost of their home purchase. It is important for prospective home buyers to understand the different types of home loans available to them. Different types of loans offer different terms, interest rates, and repayment options. They may also have different costs associated with them, such as origination fees, appraisal fees, and closing costs. If a buyer does not fully understand the terms and conditions of a loan, they may end up with a loan that has unfavorable terms or hidden fees. Doing research will help prospective buyers avoid these financial pitfalls and make an informed decision about one of the biggest financial commitments of their lives. Let's review the most common types of home loans.
Conventional Loans
Conventional home loans are mortgage loans that are not backed by the government. Instead, they are financed by private lenders such as banks, mortgage companies, and credit unions. These lenders take on the risk of the loan and make lending decisions based on their own criteria, such as creditworthiness, income, and debt-to-income ratio of the borrower. Conventional loans typically require a higher credit score and a larger down payment compared to other types of loans. Conventional loans make up more than 60 percent of the loans generated in the U.S. annually.
Common Types of Conventional Loans
Jumbo Loans: These are non-conforming loans that exceed the loan limit set by Fannie Mae and Freddie Mac. They are typically used for high-value properties.
Fixed-rate Loans: These loans have a fixed interest rate that does not change throughout the life of the loan.
Adjustable-rate Loans: These loans have an interest rate that can change periodically over the life of the loan.
Conforming Loans: If a conventional loan is less than the maximum loan amount set by the Federal Housing Finance Agency and meets additional loan standards set by Fannie Mae or Freddie Mac, it’s called a conforming loan. Because Fannie and Freddie are government-sponsored enterprises, you may also hear conforming loans referred to as “GSE loans.”
Nonconforming Loans: If a conventional loan exceeds FHFA loan limits or uses underwriting standards that are different from those set by Fannie Mae and Freddie Mac, it’s called a nonconforming loan. A jumbo loan is a common type of nonconforming conventional loan. You may need a jumbo loan to finance more than $484,350 in most U.S. counties.
Government-backed Loans
Government-backed home loans are guaranteed by the government. Government-backed loans often have lower down payment requirements and more flexible credit guidelines. However, they may also come with certain restrictions and fees that are not present with conventional loans. Government backed loans make up less than 40 percent of the home loans generated in the U.S. annually. There are three main types of government-backed home loans: Federal Housing Administration (FHA) loans, Veterans Affairs (VA) loans, and United States Department of Agriculture (USDA) loans.
Common Types of Government-backed Loans
FHA Loans: These government-backed loans are backed by the Federal Housing Administration (FHA) and are designed to help low- to moderate-income borrowers. They often require a lower down payment and have more flexible credit requirements.
VA Loans: These government backed loans loans are available to active-duty military members, veterans, and their families. They are guaranteed by the Department of Veterans Affairs (VA) and often require no down payment.
USDA Loans: These government backed loans are backed by the U.S. Department of Agriculture (USDA) and are designed to help low- to moderate-income borrowers in rural areas. They often require no down payment.
The Bottom Line:
Home buyers have a lot to consider when selecting a type of home loan. A home loan is a significant financial commitment that can last for decades. Doing your research will help you plan for the long-term financial impact of the loan and ensure that it fits within your overall financial plan.
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