If you’re shopping for a mortgage, it’s important to understand the different types of home loans available. Steve Wilcox W/Primary Residential Mortgage, Inc. offers unique benefits and may be better suited for certain situations or borrowers.
Conventional mortgages are loans originated, backed, and serviced by private mortgage lenders, not government entities like the Federal Housing Administration (FHA) or the Federal National Mortgage Association (FNMA). These loans can be used to buy a primary, second, or investment property. Conventional mortgages are typically available for borrowers with good credit and enough money for a larger down payment to avoid paying monthly mortgage insurance (PMI).
Unlike some other types of residential mortgages, conventional loans usually require higher credit scores and debt-to-income ratios and often have more stringent requirements than those offered by government agencies. However, they may offer more flexible terms than those provided by FHA or VA loans, including the ability to pay taxes and insurance through an escrow account rather than having them added to your monthly mortgage payment.
Mortgage lenders set the interest rates that conventional mortgages carry based on their credit, financial, and market analyses, their expectations for future inflation, the supply of and demand for mortgage-backed securities, and other factors. Mortgage calculators can help borrowers determine what loan amount, interest rate, and down payments will work best for them based on their circumstances and long-term goals.
A conventional mortgage can be used to purchase any property. Most lenders prefer borrowers to put down 20% or more of the home’s purchase price, which allows them to avoid paying PMI. However, lower down payments may be possible for borrowers with excellent credit and a strong income. Lenders also want to ensure that borrowers have the means to make the monthly mortgage payments so that they will ask for documentation like pay stubs, tax returns, and bank statements.
Government-backed loans are mortgages that are insured by a federal agency like the Federal Housing Administration (FHA), the Department of Agriculture (USDA), or the Department of Veterans Affairs (VA). These loan programs help borrowers who may not qualify for conventional mortgages due to their debt-to-income ratio or credit score.
The main benefit of these loans is that they have more flexible qualification criteria than traditional mortgages. This includes lower credit score requirements and lower down payment options, such as 0% down on some USDA or FHA loans. Additionally, these programs can offer mortgage interest rates that are slightly lower than conventional loans.
Conventional loans aren’t insured by the government, which means lenders take on more risk. As a result, they typically have stricter loan requirements, higher upfront fees, and mortgage insurance payments.
These loans are typically available for many people and can be a great option for first-time homebuyers needing help qualifying for a conventional loan. However, there are better fits for these types of loans, and it’s important to consider your options before choosing a loan program.
It’s also important to note that although the Federal Housing Administration, Department of Agriculture, and the VA are the backing agencies for these government-backed mortgages, they don’t make them directly available to borrowers. Instead, These mortgages are offered by private lenders approved by the government-backed entities. To find out which lenders offer these types of loans, talk to your mortgage professional or use an online lookup tool. A mortgage professional can provide a more detailed description of government-backed mortgage programs and their requirements. They can also help you compare these programs to traditional mortgages to choose the right one for your needs.
A second mortgage allows homeowners to tap into their home equity without refinancing their primary loan. Borrowers can typically borrow up to 85% of their home’s value minus their prior mortgage loan balance. This type of mortgage is typically more difficult to obtain than a traditional forward mortgage, as lenders require homeowners to retain enough home equity to be eligible for this type of financing. Additionally, second mortgages carry higher interest rates and fees than conventional loans, and defaulting on this type of financing can result in the home being seized by the lender.
Two major types of second mortgages are home equity loans and home equity lines of credit (HELOCs). Home equity loans provide borrowers with lump sum payouts repaid over a fixed term. HELOCs, however, work like a revolving line of credit that you can draw from and repay at any time.
The eligibility requirements for these mortgages can vary, but all lenders expect a high credit score and stable employment history. Lenders also review the home’s property appraisal to ensure it has sufficient value. Those considering a second mortgage should keep a folder of all the necessary documents, including pay stubs, bank and investment account statements, tax returns, and proof of income.
Conventional mortgages are the most popular residential financing option, accounting for over 9.5 million loan originations in 2021 alone. This can be beneficial for borrowers as it helps keep down the cost of borrowing. However, conventional mortgages can be more difficult to qualify for due to the strict underwriting guidelines and high credit score requirements that lenders impose.
Government-backed mortgages, on the other hand, are designed to assist borrowers who may not meet conventional mortgage requirements. The most popular types of government-backed mortgages are FHA loans, USDA loans, and VA loans. FHA loans are often a great choice for first-time buyers, as they have credit and down payment requirements than conventional mortgages.
Home equity loans and HELOCs offer borrowers access to cash based on the value of their home. Unlike a second mortgage, which requires full principal and interest payments, a home equity line of credit (HELOC) works more like a traditional credit card and typically has variable interest rates.
Applying for a home equity loan or HELOC involves submitting financial documents, including W-2s and bank statements, to prove your income, assets, employment, and credit scores. The lender will also want to know how much equity you have built in your home and verify the property’s appraisal value.
During the draw period, usually ten years, homeowners can borrow as much or as little as they want, paying only the interest on the outstanding balance. However, after the draw period, borrowers must begin making principal and interest payments on the balance owed. This is an important consideration because the lender could foreclose on the home if a borrower fails to pay back the balance.
A HELOC can be a helpful source of funds for debt consolidation, home improvement projects, or emergencies. It can also provide access to a lower interest rate than credit cards and personal loans, which makes it a good option for people who struggle with high-interest debt or bad credit.
The biggest downside to a HELOC is that spending more than you have can be easy, creating a cycle of added debt and possibly even putting your home at risk. Many lenders will only allow you to borrow up to 85% of the equity you have in your home, and some may limit access after a certain number of years.
A home equity loan and HELOC ultimately come with significant risks and rewards. Reviewing your options carefully and consulting with a lender to determine the best financing solution is important. When you do, it’s a good idea to compare rates across lenders, including big national banks, community banks, and credit unions, to get the best possible deal on your loan. Remember that your credit score impacts your interest rates, so take steps to improve it before applying.