If you’re looking to buy a new home, finding the right property is just half the battle won. Choosing the best mortgage loan type is the other half. And, you need to be wise about selecting the right one. After all, it could save you big money on your down payment, fees, and interest.

Keep in mind that there are certain mortgage loans that are better suited to a home buyer’s — depending on their financial circumstances, loan amount, zip code, and how long they plan to stay in that house.   

Choosing a home mortgage loan type isn’t as simple as it sounds. With so many loan options available, different lenders, diverse interest rates, and loan terms — the process may seem a tad overwhelming. 

Looking for a home renovation loan? Peruse through Kukun’s easy loan options. 

The good news is that each home mortgage loan type comes with its own features. Some of them are especially helpful for first-time home buyers. You need to weigh your options and select a mortgage that’s right for your financial situation. And, that’s where we help you with our loan analysis. 

We’ve listed out eight popular mortgage loan types with their pros and cons for you. You can make a mortgage commitment after perusing through them.

1. Fixed-rate loan

fixed loan rate

This type of mortgage is one of the most common types of conventional loans. As the name suggests, it prescribes a fixed interest rate with set monthly payments for the life of the loan. A typical loan term is of 15 or 30 years. 

This mortgage loan type is ideal for homeowners who’re looking for predictability in a conventional loan and plan to stay in their home for a major part of their life. 

The mortgage payment is as simple as paying X amount of money for Y number of years. The rise and fall of market interest rates won’t change the terms and conditions as well as monthly repayments of the fixed-rate mortgage. 

Bear in mind that a fixed-rate loan requires a down payment.

Same monthly principal and interest payments throughout loan termHigher interest rates than adjustable-rate mortgages
Helps homeowners set a precise budget and month-to-month expense sheet Takes longer to build equity in a home

Homeowners end up paying higher interest with a longer-term loan

2. Adjustable-rate mortgage

Adjustable-rate mortgages (ARM) have lower mortgage interest rates for a period of five or 10 years. After that, the interest rates will adjust according to current interest rates, typically once a year. 

Basically, if the interest rates shoot up, your mortgage payments will too. Or, vice versa. 

This type of loan is a good choice for homebuyers who have a lower credit score or a not-so-perfect credit report. It’s also an ideal option for people who plan to move and sell their home in the near future — ideally before their fixed-rate period is up and interest rates start fluctuating.

Lower fixed rate in initial years of homeownershipFluctuating monthly payment
Helps homeowners save substantial money on interest paymentsInvolves a certain level of risk 

Mortgage payments could become unaffordable with high rates

Once home value falls, it can be difficult to sell or refinance your house before the loan resets

3. FHA loan

Federal Housing Administration loans offer homeowners an opportunity to give a down payment as less as 3.5%. Therefore, this government-backed loan is perfect for home buyers with meager savings and those who’re unable to give a high down payment. Keep in mind that most home loans require a down payment of at least 20% of your home’s purchase price. 

However, this type of loan has a loan amount limit of $417,000. And, it doesn’t provide much flexibility. The biggest disadvantage of an FHA loan is that borrowers are required to pay for mortgage insurance — which comes to around 1% of the cost of your loan amount.

Lower down paymentComes with loan amount limitation
Great for those with fewer savingsNot a flexible loan option
Government-backedMortgage insurance is required

4. Veterans Affairs loan aka VA loan

veteran affairs loan

This is a great loan option for those who have served or are serving in the United States military. Homebuyers who qualify for a VA loan do not have to make a down payment or buy mortgage insurance. However, the property in question must be their primary residence — meeting some minimum property requirements. Fixer-uppers are not allowed.

The eligibility of a VA loan is strictly laid down by the Department of Veterans Affairs. Only those who have served 90 days consecutively during wartime, 180 days during peacetime or six years in the reserves are eligible. 

Government-backed flexible, low-interest mortgageOnly applicable on primary residences
No down payment, mortgage insurance requiredStrict loan eligibility and requirements
A great option for military veteransIncludes a funding fee

5. USDA loan

The United States Department of Agriculture-sponsored home loan is designed for the benefit of families who want to buy houses in rural areas. The government offers discounted mortgage interest rates provided the property is a USDA-eligible home. There’s no requirement for a down payment.

It’s a good choice for those struggling financially in rural areas who can’t possibly pay the high mortgage payments of other loans. The only catch is that their debt cannot exceed their income by more than 41%. Furthermore, borrowers are required to buy mortgage insurance.

Best loan option for those with  low or modest incomeOnly applicable to USDA-eligible homes in rural areas
Discounted mortgage interest ratesBorrowers need to get a mortgage insurance
No down payment requiredHigh prepayment penalties

Read more: Do You Need Mortgage Protection Life Insurance?

6. Interest-only mortgage

This loan type requires a borrower to make payments just on the lender’s interest. It’s structured similarly to an adjustable-rate mortgage. A typical interest-only mortgage has a  loan term of up to 10 years, after which the borrower can make amortized payments — split between the interest charges and principal reduction. They can even pay off the loan or refinance.

This loan offers a low monthly payment and is best suited for those with good credit, high monthly cash flow, a rising income, or good cash savings. It’s also a useful loan for home buyers looking for a short-term stay in that property. 

However, one must opt for such a loan only if one is disciplined enough to make the periodic principal payments.

A great option for borrowers in a strong financial positionRequires higher-than-average down payments
Lower monthly payment in interest-only termEligibility includes lower debt-to-income ratios and good credit scores

No gain in home equity

May require a substantial balloon payment at the end of the loan term

7. Jumbo mortgage

jumbo mortgage

Jumbo loan is a type of fixed-rate conventional mortgage, but with non-conforming loan limits. Meaning, if your home price exceeds the federal loan limits, this is a good loan option for you. Needless to say, such a loan is more common in higher-cost areas. And, it requires more in-depth documentation from borrowers.

A good option for buying a home in an expensive areaRequires a down payment of at least 10 to 20 percent
Competitive interest ratesEligibility includes an excellent credit score and low debt-to-income ratio
May give an option of choosing between a fixed or adjustable-rateBorrowers need to give proof of their assets in cash or savings account

Read more: Reasons Non-Traditional Mortgage Financing Might Be For You

8. Bridge loan

This “gap loan” is a kind of repeat financing for those who’re buying a new home before selling their previous residence. In such a scenario, your lender will wrap your current and new mortgage payments into one. And, once the old house is sold, you can pay off that mortgage and refinance.

This loan requires borrowers to have an excellent credit report and a low debt-to-income ratio. If you don’t need to finance more than 80% of the two homes’ combined value, this loan is a good choice for you.

Offers a simple way for homebuyers to transition between two housesRequires excellent credit score and a low debt-to-income ratio
Old and new mortgage payments can be combined into oneHigh-interest rates and fees
Shorter lifespan

Last words

Buying a home is an exciting phase, provided you figure out the financing angle. Once you nail down the budget for your new home, decide on plausible down payments as well as interest rates, and review your credit score — you’ll have a better idea of which mortgage loan type works best for your requirements.

Read more: Best Home Loans

8 Popular and Practical Mortgage Loan Types for You was last modified: December 7th, 2020 by Ramona Sinha
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