There Are Lots of Home Loan Types to Choose From
- There are dozens of different home loan programs available to homeowners today
- But most borrowers just go with the extremely popular 30-year fixed mortgage
- It holds a near-90% market share for home purchase loans (and also a large share of refis)
- Despite the many other products available that could save you a substantial amount of money
Types of Mortgages by Category
Conforming Loan: A mortgage backed by Fannie Mae or Freddie Mac (most common)
Jumbo Loan: A mortgage with a loan amount that exceeds the conforming loan limit (currently $726,200)
Government Loan: A home loan backed by a government agency (includes FHA, VA, and USDA loans)
Conventional Loan: A non-government home loan (can be conforming or jumbo based on loan amount)
Fixed-Rate Mortgage: A home loan that features a fixed interest rate (does not change entire loan term)
Adjustable-Rate Mortgage: A home loan with a variable interest rate (can adjust higher/lower during loan term)
Popular Loan Programs Available to Homeowners
30-Year Fixed: Interest rate never changes during entire 30-year term
15-Year Fixed: Interest rate never changes during entire 15-year term
5/1 ARM: Interest rate is fixed for first 5 years and adjustable for 25
7/1 ARM: Interest rate is fixed for first 7 years and adjustable for 23
10/1 ARM: Interest rate is fixed for first 10 years and adjustable for 20
Let’s talk about the many different loan types and programs available to prospective home buyers and existing homeowners today.
There are dozens out there to choose from, and mortgage lenders are constantly coming up with creative ways to wrangle in new customers.
The five I’ve listed above happen to be the most common and will typically be offered by most banks, credit unions, and lenders.
The type of home loan you decide to go with can make or break you as a borrower, so be sure you fully understand what you’re getting into before committing to anything.
In the early 2000s, there was an abundance of ridiculous loan programs that allowed just about anyone to buy a home, whether they truly qualified or not.
There were the now notorious 1% start rate loans, often referred to as neg-ams or pick-a-payment programs, and 40-year and 50-year term loans that stretched the mortgage payment out over what seemed like a lifetime.
Anything to keep that monthly payment down…never mind paying off the darn thing.
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 very popular since the mortgage crisis eliminated many of those riskier types of loans.
And most folks are simply going with a 30-year fixed without giving it much thought at all.
However, that doesn’t mean there aren’t interesting and potentially money-saving loan programs to suit all tastes and needs.
Aside from specific loan programs, I want to highlight the different categories of mortgages available to prospective homeowners.
Conforming Mortgage Loans and Non-Conforming Loans
- Loans eligible for purchase by Fannie Mae and Freddie Mac
- Are known as conforming because they adhere to their underwriting guidelines
- Mortgage loans that fall outside that underwriting criteria
- Are known as non-conforming loans
One way home loans are differentiated is by their government-sponsored enterprise (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 a non-conforming loan.
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 of 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 at or below $548,250 is considered conforming, whereas any loan amount above that amount is considered a jumbo loan.
However, in Alaska and Hawaii the conforming limit is 150% higher. Note that the conforming limit may also change annually, and has risen quite a bit in the past few years as home 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 Home Loans and Government Loans
- Conventional is just another word for non-government
- So it can refer to lots of different types of home loans
- Including those backed by Fannie Mae/Freddie Mac and jumbo loans
- On the other hand, FHA, USDA, and VA loans are government mortgages
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 housing agency.
Another common government home 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 for 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: Look Beyond the 30-Year Fixed
- The 30-year fixed mortgage is the most common loan program
- Mainly because it’s easy to understand and low-risk
- But you should get to know the other loan programs as well
- To ensure you make the right loan choice for your unique situation
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.
Simply put, 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 immense 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.
Loan Amount: $500,000
Mortgage Interest Rate: 6.5%
Monthly Payment: $3,160.34
Interest Paid in Year One: $32,335.45
Interest Paid in Year Two: $31,961.17
Total Interest Paid Over Life of Loan: $637,722.44
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, most people don’t stay in a 30-year loan for 30 years.
Another common and simple to understand loan is the 15-year fixed. This works exactly like the 30-year fixed except the same fixed payment is made for half the amount of time; 180 months or 15 years.
Obviously, the monthly payment will be much higher, but you will pay a lot less interest and gain more home equity in a shorter amount of time. Additionally, 15-year mortgage rates are substantially lower than 30-year rates.
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
Interest Paid in Year One: $29,432.07
Interest Paid in Year Two: $28,114.99
Total Interest Paid Over Life of Loan: $259,471.15
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, so for most it won’t even be a viable option.
We’ve just scratched the surface here. There are plenty of alternatives to fixed mortgages, including a variety of adjustable-rate mortgages like the widely used 5/1 ARM or 7/1 ARM, which could come with an even lower interest rate.
Be sure to take the time to educate yourself on the many home loan types out there and how they work.
You should be a happier homeowner with a better chance of making on-time payments. And you might even save some dough!
If you want to a run a similar comparison, simply grab a mortgage calculator and plug in your own numbers.
What Is the Best Type of Mortgage for Most Homeowners?
While best is always hard to answer universally, most homeowners are probably best off with a 30-year fixed.
It’s the most popular for a reason. The loan term is long enough to keep payments low. But not too long, allowing homeowners to eventually pay off their loans in full.
Additionally, the mortgage rates are reasonable, and often pretty cheap relative to other loan programs.
Sure, a 15-year fixed will be cheaper and paid off in half the time, but most homeowners can’t afford them. Or will be financially stretched to do so.
Then there are ARMs, which are typically too high-risk for the standard homeowner due to the variable rate feature.
In terms of loan type, that decision might be driven by down payment and qualifying criteria.
I’ve written extensively on FHA vs. conventional loans. If you’re active duty or veteran, a VA loan might be the best choice. And those in rural areas can take advantage of USDA loans.
Learn about other types of mortgage programs including:
– Adjustable-rate mortgages
– Alt-A mortgages
– Balloon payment mortgages
– 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
– Zero down mortgages
Read more: Which mortgage is right for me?