Infinite Loan Types to Choose From
There is a seemingly infinite number of home loan types out there, and mortgage lenders are constantly coming up with creative ways to wrangle in new homeowners. The type of home loan you choose can make or break you as a borrower, so make sure you fully understand it before making any kind of commitment.
In the early 2000s, you probably came across ridiculous loan programs that seemingly allowed anyone to qualify for a home loan. There were those notorious 1% start rate loans, often referred to as neg-ams or pick-a-payment programs, and 40-yr and 50-yr loans that stretched the mortgage payment out over what seemed like a lifetime.
But times have changed, and today’s mortgage loans are a lot more sensible, and mortgage underwriting much more conservative. In fact, government lending (FHA loans and VA loans) has become much more popular since the mortgage crisis eliminated many of those riskier types of loans.
However, that doesn’t mean there aren’t still a variety of interesting loan programs out there to suit all tastes and needs, with more and more creative ones being launched weekly.
Like in the past, most prospective homeowners these days seem to be interested in 100% financing, generally because they have don’t have the assets necessary for a down payment on an expensive piece of real estate.
Unfortunately, the proliferation of these types of home loan programs have increased the number of high-risk borrowers in the United States at an alarming rate. That may explain the surge in mortgage defaults and foreclosures over the past several years.
But if you take the time to educate yourself on the many home loan types out there, you’ll effectively decrease your chances of defaulting on your mortgage. That aside, let’s talk about the many different loan types and programs available today.
Before getting into specific loan programs, I want to highlight the types of loans available to potential homeowners.
Conforming Loans and Non-Conforming Loans
One way home loans are differentiated is by their GSE eligibility. If the loan meets requirements set forth by Fannie Mae and Freddie Mac, it is considered a conforming loan. If the loan doesn’t meet all the mortgage underwriting requirements set forth by the pair of GSEs, it is considered “non-conforming.”
Pretty much all mortgage lenders offer conforming loans because they are the easiest to sell to investors on the secondary market. Consider them your basic vanilla or apple pie type loan.
One of the main guidelines that determines whether a mortgage is conforming or not is loan amount. Generally, a mortgage with a loan amount below $453,100 is considered conforming, whereas any loan amount above $453,100 is considered a “jumbo loan.“
However, in Alaska and Hawaii the confirming limit is $679,650. Note that the conforming limit may change annually, and has risen quite a bit in the past few years as housing prices skyrocketed.
A jumbo loan may meet all of Fannie Mae and Freddie Mac’s loan requirements, but if the loan amount exceeds the conforming limit, it will be considered non-conforming and typically carry a higher mortgage rate as a result.
If your loan amount is on the fringe of the conforming limit, sometimes simply dropping your loan amount a few thousand dollars can lower your mortgage rate tremendously, so keep this in mind anytime your loan amount is near the limit.
Conventional Loans and Government Loans
Mortgages are also classified as either “conventional loans” or “government loans.” Conventional loans can be conforming or jumbo, but are NOT insured or guaranteed by the government.
Then there are government loans, such as the widely popular FHA loan. This type of mortgage is backed by the Federal Housing Administration (FHA), a government agency.
Another common government loan is the VA loan, backed by the Department of Veteran Affairs, which allows zero down financing. There’s even a USDA home loan backed by the same folks that grade steaks! It too allows 100% financing.
Now that you know a bit about different home loan types, we can focus on home loan programs. As I mentioned earlier, there are a ton of different loan programs out there, and more seem to surface every day. Let’s start with the most basic of mortgage loan programs, the 30-year fixed-rate loan.
Home Loan Programs
The 30-year fixed home loan is as simple as they come. Most mortgages are based on a 30-year amortization, meaning they are paid off in 30 years, and the 30-year fixed is no different.
It works just like how it sounds; it’s a 30-year term mortgage with an interest rate that is fixed for the entire 30 years. What this means is that the loan will take 30 years to pay off, and the rate will stay fixed during those entire 30 years. There isn’t much else to it. This explains its popularity among home buyers.
Let’s say you secure a rate of 6.5% on a 30-year fixed loan with a loan amount of $500,000. You’ll have monthly mortgage payments of $3160.34 for a total of 360 months, or 30 years.
You will be required to pay the same amount each month until the loan is paid off. So the total amount you would pay on a $500,000 loan at 6.5% over 30 years would be $1,137,722.44.
Monthly Payment: $3,160.34
Total Interest Paid over Life of Loan: $637,722.44
Interest Paid in year one: $32,335.45
Interest Paid in year two: $31,961.17
Average Monthly Interest Paid over Life of Loan: $1,771.45
Each year, though the monthly payment stays the same, the composition of the payment changes, with more money going toward the principal balance and less going toward interest, due to a smaller outstanding balance each month the loan progresses.
You will also need to pay property taxes and insurance on top of this mortgage payment, so keep that in mind when figuring out how much house you can afford. And don’t forget closing costs either!
While the numbers above look steep, but most people don’t stay in a 30-year loan for 30 years. They either pay it down quicker by making higher monthly payments (biweekly mortgage payments), or they may sell or execute a rate and term refinance.
Another common and simple to understand loan is the 15-year fixed loan. This works exactly like the 30-year loan except the same fixed payment is made in half the time, 180 months or 15 years.
People who have an ample amount of income usually prefer this type of loan to reduce the overall cost of financing a mortgage.
This is how it breaks down, assuming the same loan amount at a rate of 6%:
Monthly Payment: $4,219.28
Total Interest Paid over Life of Loan: $259,471.15
Interest Paid in year one: $29,432.07
Interest Paid in year two: $28,114.99
Interest Savings Over Life of Loan: $378,251.29
The monthly payment is significantly higher, but the amount of interest paid over the life of the loan is much less. Because you’re putting more money toward the principal balance of the loan, you’re paying less interest each month versus the 30-year fixed loan. As you can see, the interest savings are nearly $400,000 if you elect to go with the 15-year fixed mortgage.
It may seem like the obvious loan choice, but it’s more complicated if you factor in tax deductions and the potential of investing that money elsewhere. Not to mention many prospective home buyers probably can’t afford a monthly mortgage payment that high to begin with.
If you want to a run a similar comparison, simply grab a mortgage calculator and plug in your own numbers.
Learn about other types of mortgage programs including:
– Adjustable-rate mortgages
– Alt-A mortgages
– Balloon payment mortgage
– Bridge loans
– Hard money loans
– Home equity lines of credit
– Interest-only home loans
– Islamic mortgages
– No cost loans
– No documentation loans
– Option arm mortgages
– Refinance loan
– Reverse mortgages
– Second mortgages
– Stated income mortgages