different types of home loans

The 6 Types Of Home Loans – Which Is Right For You?

May 8, 2019 BY AFFCU in

Different families have different needs, but when it comes to buying a home, most people need some form of financing. The options you’ll find are nearly as varied as family situations are, and each one offers its own advantages.

Different Types Of Home Loans

Here, we’ll introduce six different types of home loans you’ll find and discuss how to determine which is best for you.

1. Conventional Fixed-Rate Mortgage

The first type of home loan is your conventional fixed rate mortgage. With this option, you’ll make a down payment—usually at least 10%, but preferably 20%—on the price of the home and pay a consistent monthly payment for the duration of the loan.

Most conventional mortgages last either 15 years or 30 years. The more years on the loan, the lower your monthly payments will be, but the more you’ll end up paying in interest.

The main advantage of a fixed-rate mortgage is that your interest rate doesn’t fluctuate, so if rates are currently low, you can lock in a lower rate for the life of the loan.

2. Adjustable-Rate Mortgage

An adjustable-rate mortgage, or ARM, is largely the same as a fixed-rate mortgage except that the interest rate isn’t fixed. The amount of interest you pay each month could rise or fall based on current market trends.

In most ARMs, you’ll have a brief period (usually five years) when the interest rate won’t fluctuate. After that, it will be adjusted every year.

The primary advantage of an adjustable-rate loan is that your initial interest rate will almost always be lower than that of a fixed-rate mortgage. Some homeowners start with an ARM and then refinance to a fixed rate when market conditions improve.

3. FHA Loan

Next are loans guaranteed by the U.S. Government, starting with the Federal Housing Administration (FHA).

FHA loans are designed to be more accessible than conventional loans, with lower down payments—as low as 3.5%—and less stringent qualification requirements.

FHA loans are great for first-time home buyers, but repeat buyers can use them as well. The main requirement is the loan must be for a house that will be used for a place of residence, so no flipping or investment property is permitted.

While qualification is a bit easier, they do tend to have higher interest rates than conventional loans, so that should be considered.

4. VA Loan

A VA loan, guaranteed by the U.S. Department of Veteran Affairs, requires the borrower to be a veteran, service member, or the spouse of a service member who died fulfilling their duties.

VA loans require no down payment, and they tend to have lower rates and less demanding qualification requirements than other loans. For those who have served in the military for extended periods of time, a VA loan is a great option.

5. USDA Rural Housing Loan

Those living in rural areas—really, any area outside of a large city—may be eligible for a USDA rural housing loan.

Like VA loans, this loan doesn’t require any down payment, but you need to fall within their income limits and credit requirements. As with FHA loans, the property you buy with the loan must be used as your primary place of residence.

6. Mortgage Refinancing

If you’ve already purchased a home and are currently paying off your mortgage, you might have the option to refinance. Refinancing is essentially getting a new loan to pay off the remainder of your original mortgage.

There are a few reasons why you’d want to refinance your mortgage:

  • Take advantage of lower interest rates
  • Switch from an adjustable-rate loan to a fixed rate/li>
  • Pay off a mortgage sooner by switching to a shorter term
  • Lower monthly payments with a longer loan term

Certain refinancing options also allow you to borrow a little extra, giving you some additional cash to use for large expenses.

Choosing The Right Type Of Home Loan for You

When choosing a home loan, consider several factors in your decision.

Monthly income

Your monthly income is a huge factor since it determines how much debt you can afford to take on. If your monthly income is lower, you’ll want a longer term to keep monthly payments down.

Also, a low income can run into debt-to-income issues. If your ratio of debt to income would be too high, you probably won’t qualify for certain loans. FHA loans allow higher DTI ratios, so that may be an option worth considering.

However, if you have a higher level of income, you’ll benefit more from a shorter term with a conventional loan.

Credit score

Most loans have minimum credit requirements, including conventional mortgages and USDA loans. If your credit is poor, FHA or VA loans are a more likely option.

A lower credit score may also warrant using an ARM at the start, then refinancing once you’ve improved your score. Higher credit will get you better rates, making this a potential strategy.

Location

Location mainly comes into play with USDA loans. If you plan to live in a rural or suburban area, you may qualify for a USDA rural housing loan, allowing you to benefit from no down payment and lower rates.

Current savings

Typically, if you can make a large down payment, do so. If you have enough savings to pay 20% of your mortgage, going with a conventional fixed-rate loan will often be the best option.

Interest rates

Interest rates fluctuate over time. If they’re currently high, an ARM may be better than a fixed-rate loan.

On the other hand, you’ll want to lock in a lower rate from the start if you have the opportunity to do so.

Getting Started Finding The Best Type Of Home Loan

To get started with a home loan, you’ll want to discuss your options with your lender. They’ll take a good look at your financial situation and credit history to help find the best type of home loan for you.

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