Today’s home loan and home mortgage industry offers a plethora of home financing products that can often confuse and overwhelm the first time buyer.
But, while the jargon and acronyms can seem mysterious and complex, most home loan programs fit into one of two primary categories; conventional and government loans.
Read on to learn the types of conventional and government loan programs available and the pros and cons of the different types of loans within each category.
We have made understanding home loans as uncomplicated as possible for you in this basic overview of the types of home mortgages generally available, whether you are purchasing a home for the first time, refinancing or considering selling your existing home to purchase another!
Conventional Home Loans
Unless you qualify for an FHA, VA or an RHS loan, then you will most likely apply for a conventional home loan through a lending institution. These institutions generally must comply with established guidelines in order to obtain the funds they in turn need in order to make home loans to end consumers.
Conventional home loans are typically either conforming or non-conforming according to these guidelines, which are set by Fannie Mae and Freddie Mac, the two major shareholder-owned companies that purchase mortgage-backed securities from the lending institutions and then “package” many loans together to be sold to large investors.
This system of guidelines and mortgage security packaging allows huge quantities of money to be made available to American home loan borrowers while helping to protect the investors.
To qualify for a conforming, conventional loan, you must meet specific guidelines set forth by Fannie Mae and Freddie Mac relating to the maximum loan amount, credit and income requirements, down payment and suitability of the property.
For 2008, the conforming loan limits for first mortgages remain as follows:
- Single Family Residence: $417,000
- Two-family Residence: $533,850
- Three-family Residence: $645,300
- Four-family Residence: $801,950
The maximum loan amount in Alaska, Guam, Hawaii, and the Virgin Islands is fifty percent higher. Properties with five or more units are considered commercial properties and are handled under different rules outside conventional home loan guidelines.
Fixed Rate Mortgage (FRM)
The most traditional home mortgage type is the fixed rate mortgage, which gives you as a borrower the peace of mind of knowing that the interest rate is fixed for the life of your home loan and will not fluctuate.
The one potential disadvantage of a fixed rate mortgage is that interest rates may decrease later and you’ll be paying a higher rate of interest than necessary. While you can always refinance, the costs of obtaining new home financing may outweigh the savings you would realize with the new, lower interest rate.
With the FRM type of loan, you generally have a set number of equal mortgage payments to make before the loan is repaid.
The typical life of a home loan is ten, fifteen, twenty or thirty years; however you generally have the option of either making additional principal payments to accelerate the repayment or of repaying the entire principal early, in which case you can substantially reduce the total interest you would have paid during the life of the loan.
Adjustable Rate Mortgage (ARM)
With an adjustable rate home loan, the interest rate is tied to one of several established indexes, meaning that the rate of interest paid is subject to fluctuation throughout the life of the loan. ARMs typically provide a lower initial interest rate than FRMs, which can help you qualify for a larger loan amount.
ARM interest rates generally have a cap, or maximum interest rate that can be charged, offering you some protection against an exorbitantly high interest rate being charged. The obvious risk with an ARM is that if interest rates increase you will pay more interest than you would with a fixed rate home loan, which also means your monthly loan payments can increase.
With a hybrid mortgage loan, the interest rate is fixed for some period of time, typically between one and seven years, and is thereafter adjustable. This can give you some of the benefits of the ARM but with the assurance that your interest rate and payment will not increase during the initial fixed interest rate period specified.
Many people use a hybrid loan to qualify when purchasing a home with the idea of later refinancing when they have built equity and can qualify for a fixed rate mortgage. The disadvantage is that when the fixed interest rate period ends, interest rates may be lower and/or you may not have gained enough equity in your home to qualify for a fixed rate mortgage.
With a balloon mortgage, you have a shorter period to repay the loan, typically ranging from three to seven years. You make equal payments of principal, plus interest during the life of the loan, with a “balloon” payment equal to the outstanding principal owed at the end of the loan.
The advantages of a balloon mortgage are lower interest rates and lower payments during the life of the loan, since payments are usually calculated using a time span longer than that of the loan. The obvious disadvantage is that you must either have funds available at the end of the loan period to repay the outstanding principal or else need to refinance at that time.
Interest Only Mortgage
Interest only home loans are generally used to help borrowers qualify for a home loan with a relatively low monthly payment, since only interest is paid during the life of the loan, with the entire principal amount due at the end of the loan period.
The two risks associated with interest only home loans are that you will not have adequate funds available at the end of the loan to repay the principal or that the value of your home happens to decline, leaving you without enough equity to refinance. This can lead to the unfortunate circumstance that you owe more on the home than it is worth at the end of your interest only loan.
Government Backed Home Mortgages
Neither the Federal Housing Administration (FHA) nor the Veterans Administration (VA) makes home mortgage loans, but both offer private lenders protection in the case of loan defaults, which encourages lenders to extend home loans to qualified borrowers with more favorable terms than they might otherwise be qualified to obtain.
VA loans are only available to military veterans who meet the established guidelines, while FHA loans are available to some first time home buyers and low income buyers who have limited funds for a down payment.
FHA Home Loan
The Federal Housing Administration (FHA) is part of the U.S. Dept. of Housing and Urban Development (HUD), which helps qualified borrowers obtain home financing with lower down payment requirements and less stringent qualification guidelines than those required for conventional home loans.
VA Home Loan
Guaranteed by U.S. Dept. of Veterans Affairs, VA loans can be obtained by military veterans and members of the armed services with favorable loan terms, less stringent qualification guidelines and often without requiring a down payment. In most cases, a lender limits the maximum VA loan to $203,000.
The U.S. Department of Veterans Affairs does not make the home loan, but rather guarantees repayment in the case the borrower defaults. If you qualify, a certificate of eligibility is issued, which is provided to your lender when you apply for your VA home loan.
RHS Loan Programs
The Rural Housing Service (RHS), which is part of the U.S. Dept. of Agriculture, also guarantees loans for rural residents, farmers and ranchers with low closing costs and no down payment requirement.
Now you have an overview of the basic types of home mortgage loans available. With so many loan programs and the various terms and options, making a decision about the right mortgage for your situation requires careful consideration and research.
Throughout this Home Financing Guide, we will attempt to help guide and educate you in order to make the most informed decisions possible!