Whether it’s a fixer-upper, a remodeled ranch or a downtown townhouse, finding your perfect home can feel like a dream come true. But before you make your move a reality, you have another essential choice to make: What type of mortgage will you get?
What is a mortgage loan?
A mortgage loan is a type of loan used to finance a real estate purchase. With the real estate purchase (usually a home) acting as collateral, the borrower pays back the loan with interest over a certain period of time. With a home loan, that’s usually 15 or 30 years for a conventional loan, but terms vary by lender.
Read more: 10 ways to save for a down payment
Take the quiz to see which type of mortgage is right for you.
Get to know your mortgage options
As a homebuyer (or a homeowner who is refinancing), you have plenty of options to choose from when it comes to your mortgage. When exploring the different types of mortgages out there, keep in mind your home cost, down payment, how much mortgage you can afford each month and how long you’ll live in your home.
Conventional loans
These are the most common types of mortgages and are either conforming or non-conforming.
Conforming loans are not insured by the federal government, but they do meet the guidelines set by government-sponsored companies Freddie Mac (the Federal Home Loan Mortgage Corporation) or Fannie Mae (the Federal National Mortgage Association). If you have strong credit, a steady income and can make a down payment of at least 5% (sometimes 3% as a first-time homebuyer), applying for a conventional, conforming loan is likely a good option.
Non-conforming loans do not meet borrowing criteria set by lenders, whether that’s because the amount is higher than the conforming loan limit or the borrower doesn’t have the standard amount of credit or collateral. They may be a good option if you need to forgo a down payment.
Jumbo mortgages are the most common type of non-conforming loans. They exceed the loan limits set by Fannie Mae and Freddie Mac and are most common in affluent areas where homes are pricier.
Government-backed mortgage loans
Depending upon your personal situation, you might be eligible for a government-backed loan or non-conventional mortgage.
FHA loans (Federal Housing Administration) are for people with lower credit or who can’t afford a large down payment — only 3.5% is required — making them a good option for first-time homebuyers. They do require you to commit to a mortgage insurance premium that you’ll pay for the life of the loan. (Unless you can put 10% down, in which case you’ll pay an annual premium for 11 years.)
USDA loans (United States Department of Agriculture) are managed by the Rural Housing Service. These mortgages are provided to qualifying borrowers in rural areas with low-to-moderate incomes. Some USDA loans don’t require a down payment and may offer below-market interest rates.
VA loans (Veterans Affairs) are for those who have served in the military, whether active duty or veteran. These mortgages are flexible, require little-to-no down payment and have low-interest rates.
Read more: 6 homebuyer programs (plus a state-by-state guide)
Mortgage rate type
Regardless of what loan you choose, the interest rate can be either fixed or adjustable.
Fixed-rate mortgages: For these mortgages, the interest rate is locked in for the life of the loan, meaning your monthly principal and interest payment will stay the same and you can plan your budget for months and years ahead. Fixed-rate mortgages typically come in 15-, 20- and 30-year terms. Keep in mind, longer mortgage terms may mean lower monthly payments, but you’ll likely end up paying more overall in interest.
Adjustable-rate mortgages (ARM): These mortgages typically offer a lower interest rate than a fixed mortgage would for the first few years (usually between three and seven). ARMs are also less predictable and carry more potential for risk since, after the initial period, your interest rate could adjust repeatedly throughout the duration of your loan. If interest rates rise, the cost of your monthly payments will increase with an ARM. Likewise, if interest rates fall, your payments could decrease.
Mortgage refinancing options
If you choose to refinance your mortgage, you’ll likely pick between one of three common types: Rate-and-term, cash-in and cash-out.
Rate-and-term refinance: This option allows you to adjust your interest rate, the length of your loan term or both. You’d likely choose this if you want to convert from, for instance, a 5-year ARM to a 20-year fixed-rate mortgage or shorten your fixed-rate loan from 30 years to 20.
Cash-out refinance: If you want to pull out cash from your home’s equity — this is often done to finance a major home project — you may opt for this option. In this instance, you would replace your existing mortgage with a larger loan. For example, if you owe $100,000 and refinance with a cash-out loan of $120,000, you are giving up $20,000 worth of equity in your house, but you then have that amount in cash. With cash-out, lenders generally require you to maintain at least 20% equity in your house.
Cash-in refinance: This refinancing option can help you lower your mortgage by increasing the equity on your home (and reducing the amount of your loan balance). Think of a cash-in refinance as making another down payment on your home. Doing so can make your mortgage more manageable every month or allow you to qualify for a lower interest rate.
Beyond the rate
While interest rate is important, it’s not the only factor when looking for your new home and mortgage. Consider all the components as you make this monumental decision, so you can make the right moves toward your dream home.
