The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.
As of mid-2019, around 37% of homeowners in the U.S. owned their property free and clear, which means any mortgage they had was paid off. That leaves 63% of homeowners still making that payment every month. What you might not realize is that there are many types of mortgage loans, and those millions of homeowners have different rates and terms. Understanding all your options is one of the first steps in choosing the type of mortgage that’s right for you and your situation.
What Is a Mortgage?
A mortgage is a loan that you get to buy property, such as land or a home. Like any other loan, mortgages have components such as principle and interest. But since they’re for such large amounts, they can be more complex than other loans. Some common components involved in mortgages include:
- Principal. This is the part of the loan that is what you borrowed—or what’s left of that amount as you pay it down.
- Interest. Interest is what you pay to be able to borrow the principal amount. It’s usually charged as a percentage of what you owe.
- Terms. This typically refers to the structure of your loan, such as how many years it’s for.
- Insurance. You may need to pay homeowners’ insurance as part of your mortgage payment. This is property insurance that helps cover losses if your home is damaged or lost in a fire or other covered disaster. Depending on how much you put down on your mortgage or what type of mortgage loan you have, you may also have to pay private mortgage insurance. PMI is coverage for the lender—if you fail to pay the mortgage, it helps them recoup some of their losses.
- Taxes. Depending on where you live, you might need to pay property taxes on your home. This can be rolled into the mortgage and your monthly payments.
The Main Types of Mortgages
Many types of mortgages exist. Find out about some of the most common below.
What is it? Government-backed mortgages are at least partially ensured by the federal government. The loans don’t come from the federal government, however. They still come from commercial lenders.
Pros: Because the loan is government-backed, it’s seen as less risky than a conventional mortgage for the lender. That means that you might be able to get approved for one of these loans with a lower credit score or smaller down payment.
Cons: Some government-backed loans mandate PMI, which can make them potentially more expensive in situations where someone has good credit and a large down payment.
Types of Government-Backed Mortgages
- FHA Loans. Loans insured by the Federal Housing Administration can be approved with a credit score as low as 500 under certain conditions. If you have a higher credit score, you might be able to qualify for an FHA loan with only 3.5 percent down.
- USDA Loans. These loan options typically involve the purchase of homes in qualified rural areas. Borrowers must meet certain income and credit requirements.
- VA Loans. The VA provides a number of programs to assist veterans and their families with housing, including one type of loan directly from the VA. The VA also backs three types of loans, and these loans often require no down payment.
What is it? These are traditional commercial mortgages that aren’t backed by another entity such as the government.
Pros: If your credit is good enough and you have a large down payment, you might be able to score a low interest rate. You’ll also potentially save money because, with a 20 percent down payment, you won’t have to pay PMI.
Cons: Conventional mortgages typically require a credit score of 640 or more. You might also have to wait a longer period of time after a major negative item on your credit report—such as a bankruptcy—than you would have to wait when applying for government-backed loans.
What is it? Conforming mortgages are conventional mortgages that comply with standards set by Freddie Mac and Fannie Mae. These are two government-controlled agencies that buy commercial mortgages after they’ve been issued. The agencies pay the banks for the mortgages. The lenders then have more capital so they can fund new mortgages—it’s an effort that was started decades ago to help make homeownership more accessible.
Pros: The loans have to conform to standards, which means lenders must do some due diligence to ensure the borrower is not high risk. While that does mean you must have a decent credit score and debt-to-income ratio, it also means the loan will likely have a decent interest rate.
Cons: Conforming loans are limited to certain amounts. In 2020, the limit is $510,400 for single-family homes. The limits do vary slightly by location, with higher limits in especially expensive areas.
What is it? Jumbo mortgages are those that surpass the limits set by Freddie Mac and Fannie Mae for conforming loans. In 2020, then, that would mean mortgages for more than $510,400 in most areas.
Pros: Jumbo mortgages allow you to get funding for expensive or luxury properties.
Cons: Because of the size of the loan and the fact that it’s not eligible for purchase by Freddie Mac or Fannie Mae, the underwriting process can be extensive. You may have to demonstrate excellent credit as well as produce a variety of financial documents.
What is it? This is a type of adjustable-rate mortgage (you’ll learn more about this in a moment) where you only pay toward the interest for the first few years of the loan. After the introductory period is over, you pay both interest and principle, which means your monthly payments likely go up. Your interest rate is also adjusted each year based on various economic factors.
Pros: Paying interest only can significantly lower your mortgage payment at the front end of your loan.
Cons: Your payment will go up and you won’t have a fixed interest rate. Depending on what the markets do, that could increase your costs unexpectedly.
Mortgage Interest Rates
Mortgage interest rates are typically fixed or adjustable. Which one you choose depends on your financial situation and the type of loan you can qualify for.
With this type of loan, your interest rate is set in the contract and doesn’t change over the years. The advantage of this is that you know exactly what you’re going to pay and what rate you have. The downside is that if you buy a home during a time when interest rates in the market are high, you might get stuck with a higher rate.
You can seek a lower rate by refinancing your mortgage, though you’ll have to pay closing costs and other fees, and your credit and income might be reviewed again. Many people do refinance to get a lower rate to save money if they have a better credit and financial situation than they did when they bought their home.
In an adjustable-rate mortgage, or ARM, your rate is variable. That means it fluctuates periodically. How often the interest rate might change depends on your mortgage contract. The downside of an ARM is that you can be surprised with large interest rate hikes. The upside is that if you buy a home when interest rates are high, you might see a lower rate if the markets swing that direction in the future.
Terms refer to how long you take out a mortgage loan for. Many options exist, but the two most common are summarized below.
This means that you borrow the money for 15 years. The benefits of a short-term mortgage like this are that you pay your home off and own it outright much faster, and you do so with significant interest savings. The downside is that by squeezing the mortgage into only 15 years, you will have much higher monthly payments.
This is what most people consider the traditional mortgage term. The benefit is that you spread your loan out over a longer period, so you pay less each month. The downside is that by stretching out your payments, you pay more in interest over the life of the loan.
How to Get the Best Loan Terms
To save money on your home purchase, you want the most favorable terms possible. That means you want the best length of time for your needs and a good interest rate. Try these tips to achieve your goal:
- Ensure your credit score is good or excellent. If your credit score is lackluster, you might want to consider taking time to improve it before buying a home.
- Have a decent down payment. Putting 20 percent down on a home keeps you from having to pay PMI, for example. But even putting 10 percent down might help you get better rates than if you put only three percent down.
- Compare lenders and rates to find the best deal. Shopping around for a mortgage within a short period of time doesn’t hit your credit hard because generally, the credit bureaus consider multiple mortgage applications within a few weeks of each other to be a single inquiry.
Mortgages can be complicated, and there are a lot of professionals who can help you figure out which one is best for you. When it comes to working on your credit score, the team at Lexington Law might be able to help you out by investigating and disputing inaccurate negative items on your credit report. Get in touch with us today to find out more.
Reviewed by Alexis Peacock, an Associate Attorney at Lexington Law Firm. Written by Lexington Law.
Alexis Peacock was born in Santa Cruz, California and raised in Scottsdale, Arizona. In 2013, she earned her Bachelor of Science in Criminal Justice and Criminology, graduating cum laude from Arizona State University. Ms. Peacock received her Juris Doctor from Arizona Summit Law School and graduated in 2016. Prior to joining Lexington Law Firm, Ms. Peacock worked in Criminal Defense as both a paralegal and practicing attorney. Ms. Peacock represented clients in criminal matters varying from minor traffic infractions to serious felony cases. Alexis is licensed to practice law in Arizona. She is located in the Phoenix office.
Note: Articles have only been reviewed by the indicated attorney, not written by them. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.