With any home purchase, there are a lot of things to learn – including the differences between your mortgage loan options. Knowing how these different loans work in general will help you understand the mortgage process more fully and help you decide on a loan that’s right for you and your unique financial situation.
1. Conventional Mortgage Loans
Simply put, a conventional loan is a mortgage that is not insured or guaranteed by any government agency – like the Federal Housing administration (FHA), U.S. Department of Veterans Affairs (VA), or the USDA Rural Housing Service. These loans are available through private lenders such as banks, credit unions or mortgage companies.
People who choose a conventional mortgage often have more money available for a down payment, which can result in lower monthly payments. Costs for these loans also usually include origination fees, appraisal fees and mortgage insurance. Most who go this route for their mortgage have a stable financial foundation and are unlikely to default on their loan. Because these loans aren’t backed by the government, they often have higher rates and more stringent requirements. Conventional mortgages most commonly have terms of 15, 20 or 30 years.
Minimum credit score and down payment: 620, but 700 is the minimum for a good mortgage rate and 740 is the minimum for the best rates. Traditionally, a conventional loan required a 20% down payment. Lenders can now offer lower down payments to compete with FHA loans; down payment requirements vary for each lender and your individual credit history. Conventional loans do offer programs that require a 3% down payment for low-to-moderate income and/or first-time home buyer applicants.
2. Federal Housing Administration (FHA) Loans
An FHA loan is a mortgage insured by the Federal Housing Administration and issued by federally qualified lenders. They are designed for low-to-moderate income borrowers who can’t make a large down payment on a home. In these loans, the government isn’t lending the money. The borrower pays a yearly or monthly insurance premium to the FHA to insure the loan.
FHA loans are designed to help people with little credit, no credit, or even questionable credit purchase a home. In addition to (or sometimes instead of) your credit report, the lender can look at your payment history for rent, car or utilities as a way to determine your ability to pay.
Minimum credit score and down payment: Those with credit scores of 580 or higher may generally qualify for a 3.5% down payment. What’s more, the 3.5% down payment can be paid with a grant or a gift, making home ownership more widely available to those without a lot of cash.
3. Fixed Rate Mortgage Loans
If you like predictability, a fixed rate mortgage might be for you. As the name implies, fixed rate mortgages have interest rates that stay the same over the life of your loan. That means the principal and interest portion of your monthly payment will not change. Fixed rate mortgages offer predictability and stability as you are planning your budget, making them one of the most popular types of financing available. While it is attractive to know your monthly payment, fixed rate mortgages can be the most expensive in terms of your up-front costs due to higher interest rates.
Fixed rate loans can be either be conventional or backed by FHA and have terms of 15 or 30 years.
Minimum credit score and down payment: Some lenders will accept a 620 credit score but may have additional requirements including lowering outstanding debt. Down payment requirements vary depending on your lender and type of loan, but a minimum of 3% down is a good starting point.
4. Adjustable Rate Mortgage (ARM) Loans
An adjustable rate mortgage is a type of loan where the interest rate varies through the life of the loan. The starting interest rate is fixed for several years (typically 3 to 10 years), but then resets periodically. People choose an adjustable rate mortgage for several reasons, most notably for a lower initial interest rate that keep your monthly payments low during the initial term of the loan.
There are many combinations of ARMs, and that’s why is critical to understand the specific terms of your loan. For example, a 5/1 ARM means a fixed rate for five years that afterwards may adjust annually – but will not exceed the loan’s interest rate cap. ARMs can be difficult to understand. Because of the flexibility lenders have in the margins, caps on interest rates and other elements of the loan, those with little experience can get quickly be overwhelmed. And because of this variation, it’s important to compare the different types of ARMs using a mortgage calculator.
Minimum credit score and down payment: Most conventional ARMs require a credit score of 620 or higher. They also require at least a 5 percent down payment and optimally up to 20 percent or more.
If you’re thinking about buying a home, it’s important to have trusted advisor to answer your questions and create a plan that’s best for you and your financial situation. At FirstBank Mortgage, our goal is to help our customers get to a better place – whether that’s in new home or a new financial position. For more information about the different mortgage options offered by FirstBank Mortgage, click here. To search for a loan officer in your area, click here. Or, call (855) 753-6209 to speak with one of our mortgage professionals.