What Are the Various Types of Mortgages?

Most people need to take out a mortgage to purchase a home. Shutterstock

Most people need to take out a mortgage to purchase a home. But when shopping for a mortgage, it’s important to know the different types available. Mortgages aren’t one size fits all.

There are five types of mortgages, although some have subsets. It’s important to know which type of mortgage works with your short-term or long-term goals.

Conventional Loans Not Backed by the Federal Government

Conventional loans are the most popular type of mortgage. They break down into two types: conforming loans and nonconforming loans.

Conforming loans “conform” to the Federal Housing Finance Agency (FHFA) standards and guidelines concerning several factors. These are:

• credit
• debt
• loan size

Once the conventional loan meets these standards, it can be purchased by Fannie Mae and Freddie Mac. These are government-sponsored enterprises (GSEs) that make up much of the mortgage market.

Nonconforming loans do not meet FHFA standards. Jumbo loans are considered nonconforming. Because they can’t be purchased by GSEs, they are considered riskier.

With a conforming fixed-rate loan, you can put down as little as 3 percent of the home’s purchase price. But you'll need a credit score of at least 620 to qualify. You'll also need a lower debt-to-income ratio threshold than other mortgage types.

Who Benefits From a Conventional Loan?

A conventional mortgage is a good choice for those with a strong credit score and a sizable down payment.

They are flexible and generally offer competitive interest rates and flexible terms.

Jumbo Loan Surpasses Conventional Loan

A jumbo loan is an amount that surpasses FHFA’s conforming limits. For 2024, a loan higher than $766,550 is considered a jumbo loan. Because these bigger loans can’t be purchased by GSEs, they are considered riskier to lenders.

With a jumbo loan, you can finance an expensive home. Depending on the property type, it requires up to a 760 credit score.

Jumbo loans are not offered by every lender and many require a large down payment.

Who Benefits From Jumbo Loans?

If your purchase price is above the conforming loan limits, then a jumbo loan may be your best course of action. Homebuyers considering a jumbo loan need an excellent credit score, a low debt-to-income ratio, and substantial assets.

Government-Backed Loans

The federal government backs three types of loans to make homeownership accessible:

• FHA loans
• VA loans
• USDA loans

The Federal Housing Administration insures an FHA loan. This loan only requires a 580 credit score and can go as low as 500. It also requires a minimum down payment of 3.5 percent, but for lower credit scores, it requires 10 percent.

With an FHA loan, you can’t borrow as much money as you can with a conventional loan, and its ceiling is much lower. You'll also have to pay mortgage insurance premiums, which add to the costs. But because the credit score is lower, it does open homeownership up to more people.

The U.S. Department of Veterans Affairs guarantees VA loans. This loan has no minimum down payment, mortgage insurance, or credit score requirement.

However, there is a one-time funding fee paid to the Department of Veterans Affairs to support the VA loan program. Veterans who have a 5 percent or less down payment will pay 2.15 percent of the loan amount when they are first-time buyers. They'll pay a 3.3 percent fee on subsequent loans. The more money put down, the less the funding fee.

The U.S. Department of Agriculture guarantees USDA loans and helps moderate-to-low-income borrowers purchase homes in rural, USDA-eligible areas.

Although these loans don’t require a down payment or credit score, they do charge guarantee fees.

Fixed-Rate Mortgage

A fixed-rate mortgage keeps the same interest rate over the life of the loan. This means the monthly payments always stay the same. It generally has a 15- or 30-year term. But other lenders may offer other flexible terms.

If you’re planning on staying in your home for a while and don’t want a monthly payment that changes, a fixed mortgage may be right for you. It is ideal for those who want security.

A fixed-rate mortgage can overlap with a conventional mortgage.

Adjustable-Rate Mortgage

An adjustable-rate mortgage (ARM) is the opposite of a fixed-rate mortgage. With an ARM, the interest rates change over time.

You'll usually receive a lower introductory rate for a set period. After that period is over, the rate can either increase or decrease at predetermined intervals for the remainder of the loan term.

A 5/6 ARM gives you a fixed rate for the first five years. Then, the rate either increases or decreases, depending on economic conditions, every six months until you pay it off.

Your monthly payment goes up and down depending on the rate.

Why Use an ARM?

If you don’t plan on staying in your house for a long time, the first five-year lower interest payments may be attractive to you. This might work if you plan on refinancing before the five years are up.

But ARMs are risky, especially if the economy is unstable.

How to Choose a Mortgage

Finding the right mortgage usually depends on your credit score, the size of your down payment, and the house purchase price. Look around for a lender that is willing to work with you.

There are many derivatives of the mortgages mentioned, so speak to your lender and ask what mortgage would work for your situation.

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