Point of Interest
Whether you’re a first-time homebuyer or have owned your own home for years, there are several financing options available for individuals looking to purchase a new property. However, every individual will need to consider their financial situation and credit history when deciding which home loan makes the most sense for them. While FHA loans remain the most popular solution for many due to low down payment requirements and eligible property types, they certainly aren’t the only option. Specialty loans like USAA and VA, along with conventional fixed-rate and ARM mortgages, may also provide you with the right amount of flexibility you need to find the home of your dreams while reducing the risk of late payments and penalties.
For many people, there are few things as exciting as owning their own home. The idea of being able to settle down, start a family or maybe start a home business can be hard to imagine without a place to call your own. Still, becoming a homeowner can be quite overwhelming, especially when considering how to finance the purchase.
Thankfully, first-time and experienced homebuyers have a variety of options available to them when securing the funds necessary to purchase a new home. There are many different types of home loans to choose from that give buyers the financial flexibility they need to purchase their own home, regardless of their level of credit.
Different types of mortgages
While there are many mortgage and loan types for people to choose from, the six most common ones are:
- Adjustable-Rate (ARM)
Different types of home loans
Conventional loans, referred to as either conforming or non-conforming, are loans that are provided by banks, credit unions and other financial institutions. These loans are not backed by a government agency and therefore don’t offer the same features or benefits as government-insured loans. To be approved for a conventional loan, most applicants will need to maintain a FICO score of at least 660 and have a debt-to-income ratio of 45% to 50%. Conventional loans are ideal for individuals with moderate to strong credit ratings, regular income and those who are able to make a down payment of at least 3%.
An FHA loan, otherwise known as a Federal Housing Administration Loan, allows home buyers to borrow up to 96.5% of the value of the property. FHA loans use two types of mortgage premiums — UFMIP (Upfront Mortgage Insurance Premium) and Annual MIP. The Upfront Mortgage Premiums are paid once the home closes and the loan is issued. This payment is equal to 1.75% of the base loan amount. FHA loans are federally backed and easier to apply for than conventional loans because borrowers can have lower credit scores and lower down payments but still qualify. Individuals applying for an FHA loan should have a minimum FICO score of 580 and a debt-to-income ratio of 31% to 43%.
A USDA loan is a mortgage made available to eligible rural homebuyers that requires no down payment and is issued through the USDA loan program. USDA loans are also known as Rural Development loans and are available to 97% of U.S. residents. USDA loans have no maximum loan size, but the amount borrowed is limited by the household’s debt-to-income ratio. USDA loans are typically reserved for low income applicants and come with interest rates as low as 1% once approved. The minimum credit score required for these loans is usually 640. However, you can also qualify will less than adequate credit history by meeting other requirements.
VA loans, otherwise known as Veterans Affairs loans, are issued by private lenders and are insured by the Department of Veterans Affairs. VA loans are designed for active duty military personnel and their family members, so long as they meet certain eligibility requirements. What sets VA loans apart from others is that they don’t require the borrower to have a down payment. While the VA doesn’t specify its requirements for an applicant’s credit score, most loans that are approved are with a FICO score of at least 620.
A fixed-rate loan is a type of loan with interest rates that remain consistent over time. Fixed-rate loans are usually a preferred method of financing for many homeowners, as monthly payments stay the same regardless of changing market conditions. Payment of the loan is made by paying off the interest accrued, which is dependent on how expensive the loan is. Most fixed-rate loans come formatted with either 15-, 20- or 30-year terms with principal and interest payments staying the same throughout the life of the loan. The downside of a fixed-rate mortgage is that it takes longer to build equity in a home.
Fixed-rate mortgages are an excellent choice for individuals who follow strict budgets and prefer the predictability that a fixed loan provides. They are also useful when interest rates are expected to rise over the years, as homeowners can lock in lower interest rates at the time of financing. Typically, individuals applying for a fixed-rate loan will need to have a FICO score of at least 650. However, those with lower credit profiles may be approved by paying higher premiums.
Adjustable-rate, otherwise known ARM or variable mortgages, are home loans with interest rates that fluctuate up or down based on current market standards. ARMs will typically have fixed-interest periods for a set amount of time and monthly payments will increase or decrease after. This is known as a fixed-rate period or introductory rate, which for most lenders will last for the first five years of mortgage payments. ARMs follow rate indexes after the introductory period, which dictate how low or high the interest payment will be for a given year. To protect homeowners who have an adjustable-rate mortgage, most ARMs will come with certain rate caps that restrict rates from going too high from one year to the next, regardless of how the indexes are analyzed.
The minimum FICO score required for conventional ARMs is between 620 and 680. Adjustable-rate mortgages are best suited for short-term homeowners who don’t plan on living in their property long enough for their rates to rise. Alternatively, individuals who have long-term stable employment are also good candidates as they are likely able to afford potentially higher rates years down the road.