The NAR’s 2023 Home Buyers and Sellers Generational Trends reported that 78% of all buyers financed their home purchase. Mortgages represent nearly two-thirds of consumer debt in the US and most come with a 30 year term. While mortgages are generally considered “good debt” because they provide stability and equity, it’s critical to choose the best loan type for your situation given that your mortgage will likely be the largest and most long term debt you’ll hold. There are numerous options available, so it’s important for buyers to understand the differences between these loan products. Let's explore some common types of home financing.
fha loans
- The Federal Housing Administration is a part of the United States Department of Housing and Urban Development. Congress created the FHA in 1934 to make homeownership more attainable. These loans are federally insured, which means lenders can offer borrowers a better deal.
- Aimed at assisting individuals with lower credit scores and owner-occupants.
- Requires a lower down payment (3.5% for most buyers) but entails mortgage insurance premiums, which is how the FHA is funded. Mortgage insurance premiums last for the life of the loan unless a borrower puts at least 10% down, in which case MIP will be paid for the first 11 years.
- Lenders have their own requirements, but the minimum credit score and maximum debt-to-income ratio for an FHA loan is 580 (or 500 with a higher down payment) and 43%, respectively.
- Sellers are able to contribute up to 6% of the purchase price toward the buyer’s closing costs.
va loans
- Exclusive to eligible veterans, active-duty military personnel, National Guard members, Reserve members, and eligible surviving spouses. These loans are guaranteed by the Department of Veterans Affairs.
- Provides very favorable terms, including no down payment for those with full VA loan entitlement. There is also no loan limit for borrowers with full entitlement, meaning they can borrow as much as they qualify for based on income, credit, and assets.
- VA loans protect Veterans with restrictions on lender fees, therefore, buyers can expect fewer closing costs. There is also no private mortgage insurance on a VA loan.
- Sellers are allowed to contribute up to 4% of the loan amount toward a buyer’s concessions plus closing costs.
usda loans (united states department of agriculture, rural development)
- Geared towards rural and suburban homebuyers with low-to-moderate incomes within eligible areas.
- Most USDA loans are issued by partner lenders, though the department directly lends to eligible borrowers with incomes below a certain limit.
- Offers zero down payment and may include financing for home improvements.
- Typically have lower interest rates than conventional loans.
- USDA loans don’t require private mortgage insurance.
- Repayment terms are usually 30 years, but can be extended as long as 38 years with a USDA direct loan.
- Seller contributions are limited to 6% of the sales price toward the buyer's reasonable closing costs.
- View the USDA eligibility map here.
conventional loans
- Conventional loans usually require higher credit scores and may require larger down payments. The minimum down payment is 3%. These loans are not government-backed.
- Various subtypes, including conforming and non-conforming loans, catering to diverse financial scenarios.
- Conventional loans are stricter regarding buyer’s finances, but they typically have less stringent requirements on the property’s condition compared to government-backed loans.
- Concession limits range from 3-9% of the purchase price for primary and secondary homes, depending on the loan-to-value ratio. Investment properties are limited to 2% seller concessions.
jumbo mortgages
- Designed for high-value properties that exceed conventional conforming loan limits. Fannie Mae and Freddie Mac are the two government-sponsored enterprises that set the limit on the maximum value of any individual mortgage they will purchase from a lender.
- Jumbo loans are higher risk for lenders, therefore they may require a larger down payment and have stricter qualification criteria.
- Because luxury homes are often harder to sell and prices are more subjective, many lenders require two appraisals on a jumbo mortgage.
fixed-rate mortgages (frms)
- Stability is the hallmark of FRMs, where the interest rate remains constant throughout the loan term.
- Ideal for those seeking predictability in monthly payments and protection against interest rate fluctuations.
- 92% of buyers obtained a fixed-rate mortgage, according to the NAR Home Buyers and Sellers Generational Trends.
adjustable-rate mortgages (arms)
- ARMs offer an initial fixed-rate period followed by adjustments based on market conditions.
- Suited for borrowers comfortable with potential rate fluctuations and those planning to sell or refinance before the adjustable period begins.
- 3% of buyers used a fixed-then adjustable rate mortgage and only 1% of buyers obtained an adjustable-rate mortgage, according to the NAR Home Buyers and Sellers Generational Trends. It’s not surprising that this isn’t a popular choice given the current volatility of interest rates.
Before diving into the mortgage market, it's crucial to assess your financial situation, long-term goals, and risk tolerance. Narrowing down the right type of mortgage is an essential factor in shaping your financial future. A mortgage professional can help navigate the complexities and find the loan that aligns with your unique needs.
Ready to start your homeownership journey? Get in touch with our partners at Capital Home Loans.