Buying a home isn’t a decision you’ll make lightly, so it’s a good idea to give some thought to the type of home loan you’ll get.
Choosing the right kind of home loan is important because it’s something that will be with you for many years to come.
We look at the different types of home loans available so you can be informed when you work with your mortgage professional to find the appropriate loan for your situation.
Two Types of Home Mortgage Loans
First up, at the most basic level, all housing loans can be split into two categories: fixed-rate mortgages and adjustable rate mortgages. We’ll look at each of these in detail.
These are one of the best types of home loans for first-time buyers because they’re easy to set up and to understand. You pay a set amount per month so you can plan your budget more accurately and you can feel secure about what your future payments will be.
Fixed-rate mortgages tend to have the same interest rate for the entire repayment term. A disadvantage of this is that if the interest rates go down you have to refinance to the lower interest rate which can be expensive. On the other hand, if interest rates go up, you’ll be sitting pretty.
Adjustable rate mortgages
An adjustable rate mortgage is riskier because it’s a floating mortgage that adjusts with the market. If interest rates go up, you’ll pay more in mortgage payments, and if they go down, you’ll pay less. These kinds of mortgages generally start off fixed for a period of time, usually five years, and have lower initial payments than a fixed rate mortgage before they switch to a higher adjustable rate.
After you’ve been paying your fixed-rate mortgage or adjustable rate mortgage for a number of years you may be eligible to apply for a second mortgage. Called home equity loans or home improvement loans, these loans allow you to renovate an existing property or borrow against an existing property to buy a rental investment.
Conventional vs Government Backed
Fixed-rate and adjustable-rate home mortgage loans can also be split into another two categories: conventional loans and those backed by the government.
Conventional mortgages are just your basic fixed-rate or adjustable rate mortgage that is solely paid for by you without any help from a third party. These are usually given to homeowners who can afford a 20% down payment on the price of the house, have a steady income and good credit rating.
Government-backed mortgages are guaranteed or ‘insured’ by the federal government and are usually applied for by people who can’t afford a 20% down payment on a home loan.
Called a Federal Housing Administration loan, or FHA loan for short, these type of home mortgage loans have been around since 1934 to help out people on low incomes. The FHA doesn’t lend the money; they insure the lender against any losses that may occur if a borrower defaults on their payments.
The initial investment on an FHA loan is minimal and can be as low as 3.5% of the house price, and all types of borrowers are eligible; from college students to those who have been bankrupt, there is no minimum credit score requirement.
The FHA loan seems to be an attractive choice. However, there is a drawback.You will have to pay a higher interest rate than you would with a conventional loan, and you’ll also have to pay two lots of mortgage insurance premiums, one is upfront and financed into the mortgage, and the other is paid monthly.
VA loans are offered by the U.S. Department of Veterans Affairs (VA) for active military service members, veterans, and their families. Like the FHA loan, a VA loan is guaranteed or ‘insured’ by the government, in this case, Veteran Affairs, who reimburses the lender if a borrower defaults on their loan payments.
A significant advantage of this loan is that there is no down payment needed, but borrowers must meet specific criteria and pay a one-time funding fee. This is typically around 2% of the house price but can be financed within the VA loan itself.
USDA / RHS Loans
If you live in a rural area and have a steady, low or modest income, then you might be able to apply for a United States Department of Agriculture (USDA) loan. Offered by the Rural Housing Service (RHS), and designed to stimulate growth in rural areas, this loan program is for homebuyers who can’t afford a down payment for a conventional loan. The USDA helps out homebuyers by insuring the mortgage issued by a participating local lender.
Again, as with VA loans, certain income and credit requirements have to be met by the homebuyer, and the property you buy has to be deemed eligible for the scheme. But with this type of loan, you don’t need a down payment, and it has low-interest rates. Though you will need to pay mortgage insurance if you put little or no money down.