Very few people can purchase a new home outright with the cash they have on hand. Instead, to realize their dreams of owning a house, nearly all families rely on home loans. Also known as mortgages, these loans require borrowers to pay back a large sum of money with interest over a specified period of time. The borrower’s purchased home acts as collateral, so if they fail to repay the loan, the lender can claim their home through foreclosure. Several different types of home loans exist, so we encourage you to compare the pros and cons of your options before selecting a mortgage.
Types of Home Loans
The term conventional loan can be used to describe any loan not backed by a government-sponsored agency (like the FHA and VA). Some call them “conforming loans,” because they conform to the guidelines of the two largest investors of conventional loans: Fannie Mae and Freddie Mac. Borrowers must have a FICO score of 620 or above (source), and the loan amount cannot exceed $417,000 for a single-family home (source). There are two basic types of conventional loans, fixed rate and adjustable rate, which we will discuss in more detail below.
Conventional loans work well for borrowers with good or excellent credit. They utilize conservative guidelines regarding their credit score requirements, minimum down payments, and debt-to-income ratios. Although conventional loans require less hassle to obtain if you qualify, you will need superb credit if you want the lowest interest rates. In addition, if your down payment is less than 20%, you will be required to purchase Private Mortgage Insurance (PMI), which protects the lender in case of default (source).
Unlike a conventional loan, which requires PMI if you put down less than 20%, FHA loans are backed by the Federal Housing Administration (FHA). Although many first-time homebuyers select FHA loans, you don’t have to be purchasing a home for the first time to make use of an FHA loan. They require a minimum down payment of 3.5%, and your credit score won’t influence your insurance premium. The maximum loan amount available through an FHA loan is currently $278,300 in Kansas City (source).
Many homebuyers choose FHA loans, because they don’t require a strong credit score and they can work for people trying to get back on their feet following a financial difficulty (bankruptcy, foreclosure, short sale, etc). They also allow borrowers to spend a higher percentage of their income on monthly debt payments (mortgage, credit card, student loans, car loans), unlike conventional mortgages, which typically only allow a debt-to-income ratio of 45% or less (source). For borrowers with a low credit score and a high debt-to-income ratio, FHA loans are often the only mortgage option available.
The U.S. Department of Veterans Affairs (VA) also insures home loans. To qualify for a VA loan, you must be an active-duty or veteran member of the military (Army, Air Force, Marines, Navy, Coast Guard, and National Guard), and you must meet the VA’s eligibility requirements. Spouses of active-duty military members and veterans can also qualify (source).
Offering numerous benefits when compared to conventional and FHA home loans, VA loans are very popular amongst those who qualify. They don’t have a maximum loan amount, so you may qualify for 100% financing. They also don’t have mortgage insurance premiums, and they don’t require a down payment. Although the VA charges an upfront funding fee (1.25 to 3.3% of the total loan amount), the fee can be paid by the seller or rolled into the loan. In some cases, the borrower may need to pay for closing costs and the earnest-money deposit (source).
Similar to the two previous types of home loans, USDA loans are insured by the U.S. Department of Agriculture (USDA). Like other loans insured by government agencies, borrowers must follow strict guidelines and property requirements to qualify. Although properties in rural areas always qualify for USDA loans, sometimes homeowners in the suburbs can use them as well. USDA loans do not require a down payment, and contrary to popular belief, you don’t need to be a farmer to use one. Your income and location will determine your eligibility (source).
As there are several different types of home loans insured by the USDA, you will need to further research your options if you would like to pursue this form of mortgage. Three USDA programs help Americans buy homes: loan guarantees, direct loans, and home improvement loans and grants (source). To determine if you qualify for a USDA loan, review the eligibility guidelines.
If you’re interested in purchasing a fixer-upper and renovating it after closing, you could pursue a renovation loan. You can also use a renovation loan to upgrade your current home. The loan amount will be based on the appraised value of the home after you make improvements, and only a low down payment is required. Using a renovation loan, you can repair or renovate many different features of your home, such as the foundation, roof, kitchen, bathrooms, and landscaping. You can even use a renovation loan to improve your home’s energy efficiency (source).
There are several different types of home loans available for renovations, so you will need to shop around to find the loan that best fits your needs. For example, some types of renovation loans suit older homes in established neighborhoods, some work well for cosmetic repairs, and some can help you purchase a foreclosed property. You might be interested in the FHA 203k Renovation Loan, the HomeStyle® Renovation Loan, or Jumbo Renovation Financing (source).
When you use a bond loan, a mortgage revenue bond will partially subsidize a portion of the costs you pay to borrow funds. Cities, states, and similar entities often issue these bonds to first-time homebuyers. Sometimes the loans are designed to accommodate borrowers with low incomes, and they can also be used to motivate homebuyers to purchase homes in underserved areas (source). When the real estate climate prevents people in lower income brackets from buying homes, bond loans can prove extremely beneficial. After all, compared to private lenders, state and local governments can offer mortgages with more generous and lenient terms.
Bond loans vary from government to government, but most are 30-year, fixed-rate mortgages. In addition, borrowers’ income must not exceed a specified limit. Contact a loan officer to learn about the bond loan programs offered in your area (source).
As you might have guessed, jumbo loans allow homebuyers to borrow more funds than they would be able to borrow with a conforming loan. In most counties of the United States, the limit for a jumbo loan must exceed $417,000, but some areas allow conforming loans of up to $625,500 so the jumbo must exceed that number (source). They come in fixed-rate and adjustable-rate options, and you can use a jumbo renovation loan to repair or renovate your new home.
To qualify for some jumbo loans, your lender may require two appraisals instead of the typical one. Most jumbo loans require a large down payment, though this depends on the lender. For example, some lenders require a minimum down payment of 20% or more. In addition, most lenders will require a high credit score, a low debt-to-income ratio, and 6-12 months of reserve funds (source).
In addition to selecting from the various types of home loans, you may be able to choose whether you would like a fixed-rate loan or an adjustable-rate loan.
If you fix your interest rate, it will not change. The interest rate applied when you set up the loan will be the interest rate throughout the length of the loan. Fixed-rate loans provide stability, so even if inflation surges, your interest rate will remain the same. They make it easy for homebuyers to understand their rates, and they help people to budget and manage their money. However, they fail to take advantage of falling rates and cannot be customized. As they don’t offer a reduced rate at the start, they can be expensive for some homebuyers as well.
If you choose an adjustable rate, it will fluctuate over time. Typically, adjustable-rate loans begin with a lower interest rate, which lasts for a specified introductory period. After that, your rate may go up. The adjustable rate takes advantage of changes in the market, helping borrowers save and invest more of their money without refinancing. And if you don’t plan on living in your home for long, this type of loan can help you save money. However, adjustable rates can rise significantly over their lifetime, and the first adjustment may startle and stress the borrower.
Many of the types of home loans listed above allow you to choose between a fixed rate and an adjustable rate.
Lenders often offer special programs to assist buyers with specific needs. For example, a first-time homebuyer program might provide options for low down payments, fixed- and adjustable-rate mortgages, and the ability to use gifts as well as grants and cash for down payments. Explore the programs offered by your lender to see if any might benefit you.
Finally, if you’re ready to buy a house and you live in the Kansas City area, contact PrimeLending today. Our team is committed to helping you navigate the home financing process, so that you can purchase the home of your dreams. At our branches located throughout Kansas City, we can help you explore our wide variety of loan products and programs. Plus, PrimeLending utilizes delegated underwriting, local appraisers, and cutting-edge technology to accelerate the underwriting and closing processes. When you’re ready to learn more, please give us a call at 844-701-5626. We would be happy to help you further compare the many types of home loans available to you.