You’ve crunched the numbers and determined how much you can afford to spend on a home, and how much of a down payment you can make. Next comes a task that many people expect to be daunting and confusing but is straightforward: choosing the right type of mortgage.
While there are dozens of options available, here are three common types of residential mortgages according to Alexander Diaz de Villegas, a real estate agent with Homestead Florida-based Battlefield Investment Group.
Conventional mortgages are offered through private lenders (e.g. banks, credit unions, mortgage firms, etc.), and cannot exceed a dollar amount that it set annually by the Federal Housing Finance Agency (FHFA). In 2019 in most of the U.S., this amount is $484,350. In addition, a minimum FICO score of 620 is required, and debt-to-income ratio cannot be more than 50 percent.
Alexander Diaz de Villegas adds that there are some key advantages of conventional mortgages, such as that overall borrowing costs tend to be lower than insured mortgages, the PMI can be cancelled after generating 20 percent equity in the home, and Freddie Mac and Fannie Mae-guaranteed mortgages are available for as little as three percent down.
Jumbo mortgages are like conventional mortgages, except they are for homes that exceed the maximum loan limit established by the FHFA. As a result, they typically require more substantial application documentation than conventional mortgages. Alexander Diaz de Villegas explains that to qualify for a jumbo mortgage you must have a very good credit score (typically 700 or higher), debt-to-income ratio cannot exceed 45 percent, and you must have at least 10 percent of the loan amount in savings accounts or cash. Jumbo mortgages are designed for luxury properties, and to finance homes in hot housing markets.
Government-issued mortgages are offered by three federal entities: Federal Housing Administration (FHA), Veterans Administration (VA), and United States Department of Agriculture (USDA).
FHA loans are available in fixed terms of 15 or 30 years, and require lower down payment amounts and minimum credit scores compared to most conventional loans. However, they carry two mortgage premiums: an up-front premium that is 1.75 percent of the loan amount (and which can be financed into the overall loan), and an annual premium that is between .45 and 1.05 percent of the loan, depending on the term and the initial loan-to-value (LTV) ratio.
VA loans are designed to provide members of the U.S. military (both active duty and veterans) and their families with low-interest, flexible mortgages. No down payment or PMI is required, and an up-front funding fee (along with other closing costs) can be rolled into the overall loan.
USDA loans are available to low-income and moderate-income borrowers located in rural areas. Some borrowers with low incomes in certain areas of the country are not required to make a down payment.
Alexander Diaz de Villegas adds that government-issued mortgages are typically best suited for borrowers who do not qualify for a conventional mortgage.
Once you determine what kind of mortgage you need (or most likely, what you qualify for and what you don’t), your next step will be to decide whether an adjustable rate mortgage (ARM) or fixed-rate mortgage is the right choice. The interest rate of ARMs fluctuates based on prevailing market conditions, while the interest rate for fixed-rate mortgages remain unchanged through the term.
Alexander Diaz de Villegas concludes that the best advice is to work with your real estate agent, who will help you get a clear idea of what type of mortgage is best for you, and whether an ARM or fixed-rate mortgage fits your specific risk and financial profile.