Loan Types Explained: What They Are and Who They’re For
Embarking on the journey of homeownership is an exciting and significant step in many people's lives.
Purchasing a home is a big deal – whether you’re a first time home buyer or you’ve been through the home buying process before – and there are a lot of decisions that come with a big move.
One of those decisions being loan types! Many people find the financing portion of home buying to be confusing and it causes them to delay their action because they simply don’t understand how it works.
Here at The Real Estate Collective, we understand that the world of real estate can be confusing, especially when things are changing on a daily basis, so instead of you having to calculate math equations in your head and dig through Google for answers to your burning questions, we’re here to make it easy for you!
Home ownership is something that everyone deserves to experience if they choose, which is why providing the education you need to make smart moves is the name of the game around here 💃🏼
If you’ve been thinking about purchasing a home, but the different loan types leave your head spinning – we’ve got you!
Let’s dive into the five most common loan types, what they mean and who they’re for so you can have the clarity you need to confidently make moves toward homeownership.
5 Common Loan Types: What They Are and Who They’re For
Conventional Loan
A conventional loan is a type of mortgage that is not insured or guaranteed by a government agency, such as the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). This usually means little to no mortgage insurance which gives you a lower payment.
These loans are offered by private lenders, such as banks, credit unions or mortgage companies, and follow guidelines set by two government-sponsored enterprises: Fannie Mae and Freddie Mac.
Loan Guidelines:
Can be used for a primary home, second home or investment property
Requires a down payment of at least 3-20% of the home's purchase price (depending on the lender's requirements and your financial profile as the borrower)
Minimum FICO credit score of 620 or higher
Must have a debt-to-income (DTI) ratio of no more than 45%
Generally speaking, conventional loans often have more strict credit score and income requirements compared to that of government-backed loans and with these strict requirements, larger down payments are often required as well.
Interest rates for conventional loans can be fixed or adjustable, allowing you the flexibility to choose the option that best suits your needs.
While conventional loans may require a larger down payment and have stricter qualifications, they do offer a few advantages, including flexible loan terms, lower mortgage insurance costs and the ability to finance various types of properties.
When it comes to appraisal provisions (what the appraiser looks for in property condition), conventional loans are king. There isn’t much that won’t allow a property to qualify conventionally - making these types of loans well liked by Sellers.
Who These Are For: Conventional loans are best suited for those who have strong credit scores and have the funds readily available to make a large down payment. With this loan option, a 30-year fixed mortgage is a popular choice.
Jumbo Loan
A jumbo loan is a type of non-conforming loan that exceeds the loan limits set by Fannie Mae and Freddie Mac. These loan limits vary by location and are adjusted annually to reflect changes in the housing market.
The overall purpose of jumbo loans is to provide financing for higher-priced properties that exceed the conforming loan limits.
Since these loans are not eligible for purchase by Fannie Mae or Freddie Mac, they carry a higher level of risk for lenders, which can result in stricter qualifications and potentially higher interest rates.
Loan Guidelines:
Commonly used for more expensive homes
Requires a down payment of at least 10-20%
Minimum FICO credit score of 700+
Must have a debt-to-income (DTI) ratio of no more than 45 percent
To obtain a jumbo loan, in-depth financial documents are typically required and you must be able to prove that you have significant assets in cash or savings.
The specific terms and requirements for jumbo loans can vary among lenders, so it's important to shop around and compare offers to find the best terms and rates available.
Who These Are For: Jumbo loans are best suited for those looking to finance a home with a selling price that exceeds the conforming loan limits.
This is a common scenario for luxurious vacation homes, rental properties, or primary residences in higher priced areas throughout the country, such as California, New York and other popular cities.
Government-backed Loan
Government-backed loans are insured by a government agency, which means they provide certain protections to lenders. This often plays in your favor as a borrower because lenders are then able to offer more favorable terms and lower interest rates.
Government-backed loans are designed to make homeownership more accessible and affordable for individuals who may face challenges in obtaining traditional financing, which make these loans very common for first time homeowners.
The three most common types of government-backed loans include:
Federal Housing Administration (FHA) Loans – these loans are popular among first time homebuyers and borrowers with lower credit scores or limited down payment funds. FHA loans typically have more flexible qualifications and require a down payment as low as 3.5% of the purchase price.
Department of Veterans Affairs (VA) Loans – these loans are available to eligible veterans, active-duty service members and surviving spouses and offer several advantages, including no down payment requirement, competitive interest rates and the absence of private mortgage insurance (PMI).
U.S. Department of Agriculture (USDA) Loans – these loans are designed to promote homeownership in rural and suburban areas, much like the areas in various parts of Montana! These loans are available to low-to-moderate-income borrowers and typically offer zero down payment options and favorable interest rates.
Overall, government-backed loans provide an alternative financing option for borrowers who may not meet the strict requirements of conventional loans.
Even though these loans are essentially designed to move many people towards homeownership easily, it’s important to note that all government-backed loans do still have specific eligibility criteria and guidelines that you must meet as a borrower.
The only way to know the specific loan guidelines for your situation is by consulting with a trusted local lender or mortgage professional so they can do a deep dive into your financial history and help you determine which loan you qualify for.
Who These Are For: Government-backed loans are best suited for first home buyers or those who do not meet the strict requirements of conventional loans.
Fixed-rate Mortgage
A fixed-rate mortgage loan is a type of home loan where the interest rate remains constant throughout the entire duration of the loan.
With a fixed-rate mortgage, both the interest rate and monthly mortgage payments stay the same over the life of the loan, providing you as the borrower with stability and predictability – both of which are super important things as a homeowner, especially if you’re new to the world of homeownership!
Loan Guidelines:
Can be used for a primary home, second home or investment property
Requires a down payment of at least 3-20% of the home's purchase price (depending on the lender's requirements and your financial profile as the borrower)
Come in terms of 15 or 30 years, so you can decide how long you want to be locked into your loan terms
Who These Are For: Fixed-rate mortgages are best suited for those who plan to stay in their home for at least 5-7 years and want to avoid the potential changes to monthly payments and interest rates.
Adjustable-rate Mortgage
An adjustable-rate mortgage (ARM) is a type of home loan where the interest rate can fluctuate over time.
Unlike a fixed-rate mortgage where the interest rate remains constant, an ARM has an initial fixed-rate period (typically ranging from 3-10 years) and afterwards the rate will adjust periodically based on the market.
Loan Guidelines:
Requires a down payment of at least 3-5%
Minimum FICO credit score of 580
Must have a debt-to-income (DTI) ratio of no more than 50%
An adjustable-rate mortgage is very rarely something that I would advise for someone due to the fact that your payments can substantially rise, making your mortgage completely unaffordable.
With that said, there are some scenarios where an ARM can be a great option for you as a borrower.
Who These Are For: Adjustable-rate mortgages are best suited for those who are buying when interest rates are high OR if you plan on selling your home within five years or during the adjustment period of the loan.
Need More Home Buyer Guidance?
As you embark on the exciting journey of purchasing a home, understanding the different loan types available to you is vital for making informed decisions that align with your financial goals!
Whether you're exploring conventional loans with their stability and wide-ranging options, government-backed loans providing accessible financing solutions or adjustable-rate mortgages offering flexibility and potential savings, each loan type has its own unique features and considerations.
By understanding the key differences between the major loan types, you’ll be able to navigate the path to homeownership with confidence and that’s ultimately what we want for you here at The Real Estate Collective!
After learning about the different loan types available to you, you may still have some questions and if so, that’s what we’re here for. Connect HERE to ask your questions and receive guidance based on your specific scenario.
And if you’re hoping to plant your roots in Montana specifically, CLICK HERE to learn about the 4 Little To No Money Down Financing Options for Home Buyers in Montana specifically!