Different Types of Mortgage Loans - A Comparative Guide
09.15.2020 | Category: Homebuying
When it comes to finding the right mortgage loan type and term for your new home purchase or refinance, the number of options available can be overwhelming. In this article, we’ll compare the different mortgage types and mortgage terms that you might come across as you look for a new home loan.
Conforming vs. Jumbo Home Loans
When it comes to finding the mortgage loan that is right for you, you’ll first need to determine the size of the loan that you’ll need. Based on the amount of your home loan, you’ll either need a conforming or jumbo mortgage loan.
Each year, Fannie Mae and Freddie Mac (the government-controlled corporations that purchase and sell mortgage backed securities) are responsible for setting the conforming loan limit. That means that any home purchased with a loan amount that’s less than the loan limit set by Fannie Mae and Freddie Mac is considered a conforming loan.
In 2020, the conforming loan limit in most areas of the country was $510,400. In high-cost areas of the country, it could be as high as $765,600. So, what does this mean for you? The interest rate on conforming mortgages are often lower than the interest rate on jumbo mortgages (or non-conforming mortgages).
A jumbo loan is a home loan that exceeds the $510,400 conforming loan limit set by Fannie Mae and Freddie Mac. In addition to higher interest rates, jumbo loans may require higher down payments, a better credit profile and more debt-to-income ratio.
Fixed vs. Adjustable Rate Mortgage
One key decision you’ll need to make as you compare the different types of mortgages is whether you’d like a fixed rate or an adjustable rate mortgage. Each option has pros and cons that should be weighed as you work through the decision-making process.
Fixed Rate Mortgage
A fixed rate mortgage will have the same interest rate for the entire life of the loan. For example, if you were to purchase a new home with a 30-year fixed mortgage, your principal and interest payment would remain the same every month for the entire 30 year term (please note, this doesn’t not take into account your taxes, insurance, and additional fees which may change over time). A fixed rate mortgage offers more stability and is often easier to budget for over the life of the loan.
Adjustable Rate Mortgage
An ARM or Adjustable Rate Mortgage is a home loan where the interest rate adjusts over the life of the loan. ARMs are usually structured so the interest rate on the loan will remain fixed for an initial period of time, and then adjust annually. For example, with a 7/1 ARM is where the interest rate for the first 7 years would remain fixed. Then after that initial 7-year period, the ARM will then adjust annually based on market rates and conditions. ARMs offer less stability than their fixed mortgage counterparts, but typically offer borrowers lower interest rates at the beginning of the loan. If you’re only planning to be in your home for a short period of time or are looking to qualify for a larger loan amount, an ARM may be worth exploring.
We know that choosing the right type of home loan can be a nerve-wracking and overwhelming experience. Let’s face it, there’s no “one size fits all” approach to lending. Remember, if you ever find that your mortgage isn’t working well for you, you can always refinance to a new option.
Government vs. Conventional Loans
There are three types of government insured loans: VA, USDA, and FHA. These loans are insured in part or wholly by the US Government. Mortgage loans that are not insured or guaranteed by the federal government are considered to be conventional loans.
If you’re able to meet the income and credit requirements, conventional loans typically offer you more flexibility and a wider array of loan programs and terms. By comparison, government mortgage loans are designed to bring homeownership within reach for Americans and often feature less rigorous requirements.
Established in 1944, the VA home loan program is a federal guarantee program that helps service members, veterans, and eligible surviving spouses become homeowners. The VA home loan allows qualified U.S. service members and veterans to purchase or refinance a home at competitive interest rates and with no down payment. In addition, VA home loan benefits include reduced closing costs, no private mortgage insurance (PMI) or penalties for prepayment. A Mutual of Omaha Mortgage VA home loan specialist can help you assess your VA loan eligibility and help you utilize this benefit.
USDA Home Loan
The United States Department of Agriculture (USDA) makes available a home loan program designed to help Americans purchase homes in rural approved areas. The program was originally designed to help low- and moderate-income borrowers, who meet certain income eligibility requirements, to finance homes in rural areas of the country. Over the years, the USDA’s definition of rural has come to incorporate many suburbs of major cities. The USDA home loan program helps bring home ownership within reach for those who may not otherwise qualify.
FHA loans are a popular type of home loan that is insured by the United States Federal Housing Administration, or FHA. These loans are common, and offer easier qualifying standards, including a 3.5% down payment option. FHA loans are ideal for first-time home buyers, home buyers with not-so-perfect credit, or those who don’t want to make a hefty down payment up front.
Understanding Interest Rates
We know one important question many borrowers have during the home buying process is: What will my interest rate be? Once you have a house under contract, you’re able to lock in the interest rate. Here are some commonly asked questions we receive about rates:
What determines my interest rate?
Your interest rate is shaped by the general level of interest rates in the economy. In addition, there are 7 personal factors: credit score, home location, home price and loan amount, down payment, loan term, interest rate type and mortgage loan type. A lender will use these items to determine your credit worthiness, your ability to repay your loan, and your interest rate. If you speak with a lender who gives you a rate without examining these factors, the rate isn't real. It’s a rate for someone, but it may or may not be the rate for you.
What is a rate lock?
Once you lock an interest rate, you’re protected from any changes in the market that could cause rates to increase. When you lock your loan, you’re essentially freezing that interest rate, so you don’t have to worry if rates go up between the time you submit an offer and close on the mortgage.
Comparing Loan Term Options
Mutual of Omaha Mortgage is able to offer mortgage programs and terms for 10, 15, 20, 25 and 30 years. Generally, when we talk about long term mortgage rates, we’re talking about 30 year mortgage rates. And when we talk about short term mortgage rates, we’re talking about 15 year mortgage rates. When you purchase or refinance to a shorter-term mortgage, you can typically qualify for a lower interest rate - which can result in big savings over the life of your loan. But it’s important to remember that shorter term mortgages usually result in higher monthly payments, because you’re paying off your loan balance over a shorter period of time.
Understanding the Savings
Compared to a 30-year mortgage, a 15- or 10-year mortgage term would equate to higher monthly payments. But you’ll be saving thousands over the life of your loan term. That savings comes in the form of interest payments.
To help illustrate these savings, let’s take a look at a sample scenario comparing a 30-year mortgage vs. a 15-year mortgage. Let’s say you purchased a home for $300,000, with 20% down, a 30-year fixed-rate mortgage with a 4.0% interest rate, you would pay more than $172,000 in interest over the life of your loan. If you took that same $300,000 home, with 20% down, and a 4% interest rate, but changed over to a 15-year term, you would pay roughly $79,000 in interest over the 15-year repayment period. That’s a saving of over $93,000 in interest payments.
While a shorter-term mortgage and higher monthly mortgage payments isn’t an option for everyone, it may be worth reviewing your options with your loan officer, so you have the whole picture of what’s available.
Mutual of Omaha Can Help You Choose the Best Type of Mortgage for You
When it comes to home financing, we know that there’s not a “one size fits all” mortgage option. That’s why our team will work closely with you to understand your current financial situation and your mortgage goals to find a loan type that meets your needs. You can expect that we’ll be by your side every step of the way, ensuring that you have all of the information that you need to make an informed decision about which type of mortgage you should get.