Part 3 of the buyer’s series is a run-down on types of home loans. This information comes from my experience. Know that loans conditions vary from lender to lender, so check with your mortgage lender for details on your specific loan and situation.
I’ve split the list of home loans into two categories: government backed and non-government backed. The reason being, government backed loans will be have pretty standard conditions and terms from lender to lender. Government backed means these are programs where the federal government has set conditions to encourage home buying, in certain areas or for people in certain financial/economic situations. They also work to lower the barrier to home buying, making it more accessible.
GOVERNMENT BACKED LOANS
VA
Veteran Assistance (VA) loans are available to those who are currently serving, in the reserves, a surviving spouse, or a veteran. The big advantage of this mortgage type is it doesn’t require a down payment or Private Mortgage Insurance (PMI). This loan type does require a termite inspection be performed. I’ve heard there are stipulations, such as years of service, so definitely check with your lender to learn more.
USDA
U.S. Department of Agriculture (USDA) loans are limited to certain geographically areas, mostly rural locations. The advantage of this loan type is that is 100% financing (of the purchase price), no down payment required, but there are income limitations. Your household income can’t exceed a certain threshold in order to qualify to use this loan type. These loans do require PMI.
FHA
Federal Housing Administration (FHA) loans are an option for individuals with less than perfect credit and putting less than 20% down on a home. The down payment requirement on these can be as low as 3.5%. The rates for FHA loans can run higher compared to other loan types and there is PMI if you put less than 20% down at closing. FHA also has more stringent limitations on the condition the home is in. It can’t have peeling paint or significant structural, environmental, electrical, or plumbing issues.
NON-GOVERNMENT BACKED LOANS
Conventional
These loans are very popular and what most buyers aims for. Conventional loans are fixed rate for the life of the loan. They come in a variety of terms (years) and down payment options, including below 20%. This loan has PMI if you put less than 20% down at closing, but these loans tend to offer lower interest rates than FHA. Conventional loans have more stringent requirements on credit history and income.
ARM
Adjustable Rate Mortgage (ARM) is a loan type where the interest rate is not fixed over the entire life of the loan. Often, there is a fixed rate period, where the initial rate is in effect, and then the rate adjusts at a set frequency. You will often see these two conditions expressed at 7/6 ARM. The first number represents the number of years the rate is fixed at the initial interest rate (determined at purchase and closing). The second number is the frequency at which the interest rate adjusts. Your lender may offer multiple different term periods.
This loan type does not require 20% down to close. Usually, a 5 or 10% down payment is required and they do not require PMI. At first glance, an ARM may seem inherently riskier but they can sometimes offer lower monthly payments for buyers not putting 20% down.
This may also be a good option if you don’t plan on staying in your current home for longer than the fixed initial rate period or plan to refinance within that period. There are caps to how much your interest rate can change, so be sure to discuss this with your lender and read the loan conditions carefully.
Land
Land loans are used to purchase parcels that are unimproved (aka, don’t have a structure). The one’s that I’ve seen require 20% down and have shorter terms, such as 1 year. These are somewhat specialized loans that not every lending institution offers. I’ve seen them offered by banks.
Jumbo
This is for when you’re borrowing more than the $726,200 limit for single family homes set by Fannie Mae and Freddie Mac. The limit was just increased in 2023 from $647,200 in 2022. These loans can be fixed or adjustable rates, they often don’t have PMI, but they do tend to have higher interest rates and can be more difficult to qualify for.
Construction
These loans are used when you’re building a new home and multiple draws on the loan are needed. Not all new home builds require a construction loan. Construction loans usually require 10 or 20% down at the initial closing, have a 9-12 month building period, and at the end of the building period some convert to a conventional loan. Usually, the value of the lot (equity) can be used toward the down payment, and you make interest only payments during the building period.
This loan type can vary greatly from lender to lender. Some lenders don’t require PMI with a down payment below 20% and some do. There may be one or two closings. I highly encourage you to shop multiple lenders for this loan type and compare conditions.
WHAT IS PMI
Private Mortgage Insurance (PMI) is insurance that is charged on top of your mortgage payment and base mortgage interest rate. Sometimes PMI is charged for the lifetime of the loan but I’ve also seen PMI disappear after you reach 20% in equity. That is, 20% of appraised value at closing. It just depends on the initial loan conditions. Be sure to ask this question.
Essentially, PMI protects the lender if the borrower defaults on the loan. Lender’s view borrows putting less than 20% down on a fixed rate mortgage at higher risk to default. Default meaning, not pay on the loan.
CLOSING COSTS
Closing costs vary based on tax rate, loan type, title company, purchase price, and other factors. WORK WITH YOUR LENDER AND REAL ESTATE AGENT TO ESTIMATE CLOSING COSTS. I cannot stress this enough. Your lender should have a pretty good idea of closing costs based on the price range and location where you are searching or plan to search, and based on your loan type. Your real estate agent will have a rough idea of closing costs charged by the title company.
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