A Home Buyer’s Guide to the Different Types of Home Loans
What is the best way to finance your new home? We explain the different types of home loans to help you pick the right one for your financial needs.
According to the National Association of Realtors, more than five million existing homes sold in 2019. Other buyers opted for new houses. It all adds up to a lot of real estate transactions every year.
If you’re thinking about buying a house, one of your concerns is probably financing. Whether this is your first home or an investment property, you might have questions about how you can get funds.
You know about the standard mortgage, but what about other types of home loans? This guide goes over them, along with their pros and cons. Keep this guide handy, and you’ll be able to choose the best financing option for your project.
The Conventional Mortgage
Conventional mortgages are the first type of home loan anyone thinks of. These loans are backed by Fannie Mae or Freddie Mac in the US.
The loan must fall with certain limits. These include limits on the size of the loan, which are determined by different counties. Home buyers must also meet requirements about their ability to repay the mortgage.
You’ll likely need to put a down payment on the property. If the down payment is less than 20 percent, you’ll need to get insurance for the mortgage.
Conventional mortgages often have lower costs, although they can be difficult to get. You may be able to put down as little as three percent, but you’ll need a good credit score and a good debt-to-income ratio.
An adjustable-rate mortgage is a type of conventional mortgage, but they have two term periods. The first period has a fixed rate, while the second allows the interest rate to fluctuate.
Adjustable-rate mortgages often have lower rates to start. You “lock in” for the fixed period at this rate. When it expires, the interest rate will follow the market up and down.
That may end up saving you money if rates continue to trend lower. If they jump, though, you can end up paying a lot more. ARMs might be a good choice if you don’t mind uncertainty and you’re able to handle the risk.
When it comes to interest rates on home loans, fixed-rate mortgages are your other option. A fixed-rate mortgage provides you with the same interest rate for the entire period.
That can be good news if interest rates are low and you expect them to climb. If they happen to dip, then you’re stuck paying higher interest.
The trade-off is certainty. You don’t need to worry about whether you’ll be able to handle your mortgage if interest rates climb.
Fixed-rate mortgages typically have higher interest rates, but they’re more stable.
Mortgages backed by Fannie Mae or Freddie Mac come in two varieties. Most conventional mortgages are called conforming loans, because they follow the rules.
There are also some loan types that are non-conforming. Jumbo mortgages are the most common of these.
What is a jumbo mortgage? It’s a mortgage that’s larger than Fannie Mae or Freddie Mac’s allowable limits for the county the home is located in.
Jumbo mortgages are harder to get than conforming mortgages, but they can help you buy in expensive areas. You’ll need to have a great credit score, as well as a down payment of up to 20 percent. In addition, you’ll need to show you have assets worth approximately 10 percent of the home.
The debt-to-income ratio requirements are also stricter.
Balloon Mortgages and Interest-Only Mortgages
These two types of mortgages are unconventional in how they structure your payments. You’ll still need a good credit score and debt-to-income ratio to qualify for them. So, how do they work?
With a balloon mortgage, you’ll make a large payment at the end of the term. This can help you become mortgage free faster, but it can also be tough to manage a large payment.
Interest-only mortgages offer the home buyer a certain term where they’ll make interest-only payments on the mortgage. This can make it easy to manage the mortgage as you get settled in.
When this term expires, you’ll begin paying principle on the mortgage as well. Only now will you begin to pay down the loan.
Interest-only loans can look attractive upfront, because their payments will be small. Adding in the principle can drastically increase the payments. Be sure you’re ready for the increase.
A bridge loan is a short-term home loan used to help you as you move between properties. It’s designed to help you “bridge” the gap between buying a new home and selling your existing property.
The bridge loan allows you to carry a dual mortgage on the two properties. Bridge loans typically come with high interest rates, and their amount can be quite high as well.
Once you sell your existing property, you’ll pay back the bridge loan and roll over to a more conventional loan.
This option is a good short-term solution for those who want to buy that perfect property, but haven’t sold their existing home yet.
Government-Backed Types of Home Loans
The government offers several different programs to help home buyers get the funds they need. These include:
- Veterans Affairs (VA) loans
- Federal Housing Administration (FHA) loans
- USDA loans
VA loans are only available to members of the military. They have lower requirements, such as no down payments.
FHA loans help buyers, especially those who don’t have a large down payment or have less than stellar credit. You’ll end up paying two insurance premiums if you put down less than 10 percent on your new home.
USDA loans are for borrowers in rural areas. To be eligible, your income must be below certain limits. You may not need a down payment.
Typically, these loans help first-time buyers get into the market.
Rental Property or Vacation Property Loans
If you’re looking at an additional property, then you may want to look at a loan specifically for the type of property. You can find vacation property loans and rental property loans.
These often work like a conventional mortgage. There may be more strenuous requirements. You may need to have a much larger down payment.
The reason for this is that lenders don’t want buyers to feel overextended. People with two large loans, like a mortgage and a rental property loan, have a higher debt load. They’re more likely to default.
If you’re looking for a way to get a down payment on a new property or even to buy another one outright, then you might look at a reverse mortgage.
Also known as a home equity line of credit, these loans give you access to equity in your home. If your home has valued since you bought it, you may qualify for a loan that gives you access to the “extra” value, over and above your mortgage.
When these loans are structured are a line of credit, you can pay the money back and use it again as you see fit. Lenders will give you a certain percent of the home’s market value, less any liens or loans.
A home equity loan is often used for renovations to a property. It can also be used to meet your other property goals.
Hard Money Loans
One of the best options out there for people looking to get into investment properties is a hard money loan. These loans are sometimes known as “fix-and-flip” loans. It’s an apt name, because they’re perfect for flipping houses.
A private lender will extend a short-term loan. The loan amount will usually allow you to buy the house and to cover the cost of repairs. The lender may assess the estimated after repair value to determine the amount of the loan.
Once you’ve fixed and flipped the house, you can pay back the loan. Since they’re short-term in structure, there’s no penalty for doing this. A traditional mortgage would have penalties.
The mortgage also wouldn’t assess the future value of the property, so you might only get enough money to buy it “as is.” That could leave you short of funds for repairing the property and flipping the house.
Hard money loans can also be the best type of home loan for those who plan to do cash-out refinancing of a property once it’s been repaired. This can be a great way to get a rental property or vacation home.
Get the Funds You Need for the Home You Want
Now that you know about most of the different types of home loans, you should have a better idea of which options you want to explore. A government-backed mortgage could be a smart move for a low-income buyer. Another type of loan could be a better fit for your situation.
If you’re planning to do a fix and flip or are considering another property, then it might be time to look for hard money lenders in your area. With their expert help, you can get the funding you need to back your next project.