How to choose the best mortgage type

Our cheatsheet to understanding different mortgage types

Wouldn’t it be great if choosing a mortgage was easy? Not one of the most complicated parts of the home buying process.

If you had a cheat sheet for understanding mortgage types?
Rather than wondering which one works for you.

If you could enjoy the home buying process?
Without worrying about hunting for a mortgage.

That’s exactly what we’ll help you with in this post by explaining mortgage types!

Choosing a mortgage type is key to finding the right mortgage. But, it’s also one of the most confusing parts. With terms like conventional, conforming, jumbo, federally insured, mortgage insurance (and more), selecting a mortgage type can feel like speaking another language.

So, we’re going to simplify mortgage types. And, help you know which one works best for you. Here’s how you can choose the best mortgage type for you.

Conventional Mortgage

One of the most common mortgage types is a conventional mortgage, which isn’t insured by the federal government. Instead, it’s insured by a private institution, like a bank. When a loan is insured by the federal government, it’s less risky for lenders to loan to people with low credit scores or high debt.

Conventional mortgages can be used to purchase any type of property — even an investment property or a vacation home.

Qualifications
As such, conventional mortgages can be harder to qualify for. To get a conventional mortgage, you generally need a credit score above 620. If you have a lower credit score, you’ll likely have a higher interest rate on your loan — meaning you’ll pay more over the lifetime of the loan.

Calculating Your Debt-to-Income Ratio
Along with your credit score, lenders look at your debt-to-income ratio — which shouldn’t exceed 50%.

You can figure out your debt-to-income ratio by dividing your monthly debt — like credit cards, student loans, or car payments — by your total income. If you have $2,500 per month in debt and you earn $5,000 each month, your debt to income ratio would be 50% (2,500/5,000).

The more debt you have each month, the less room you have to pay back any new debt — like a mortgage. So, if your debt-to-income ratio exceeds 50%, you likely won’t qualify for a conventional mortgage.

Conforming vs. Non-Conforming
If you can qualify for a conventional mortgage, you need to decide if you want a conforming or non-conforming mortgage.
Conforming mortgages follow the maximum loan limit set by Fannie Mae and Freddie Mac (federal mortgage investors). The max loan amount for most areas is currently $510,400. However, in some high-priced areas, the max is $765,600.
If you exceed these mortgage limits, then you’ll have a non-conforming loan. The most common type of non-conforming conventional loan is a jumbo loan. This just means that you’re taking out a mortgage larger than the limits set by Fannie Mae and Freddie Mac.

Down Payment
With a conventional loan, you can put down as little as 3% of the purchase price. However, if you put down less than 20% of the purchase price, you’ll have to pay for mortgage insurance (MI). Between 0.5%-2.25% of the total purchase price, MI can cost you over $100 each month.
MI reduces the risk for lenders to give you a loan. The more equity you have in your home, the less likely you are to default on your mortgage. So, with equity under 20%, you’ll need MI to reduce the risk of approving you for a mortgage.
With a conventional loan, you can ask your lender to cancel your MI once you reach 20% equity in your home. So, if you do put a low-down-payment on your home, you won’t have to pay MI for the entirety of the loan.
Conventional loans are non-federally insured loans that have high credit/debt requirements — but low down payment requirements. If you have good credit but not much saved up for a down payment, a conventional loan could be a good choice.

Pros of Conventional Loans

• Low down payment requirements
• Option for large loan amount
• MI can be canceled

Cons of Conventional Loans

• High credit requirements
• Higher interest rates for lower credit scores
• Might need MI

Federally Insured Mortgages

Another mortgage type is federally insured mortgages. The federal government insures a variety of loan programs. Being federally insured makes it easier for people with low credit scores and little saved for a down payment to qualify for a mortgage.

FHA Mortgage
One of the most popular types of federally insured mortgages is an FHA loan. Backed by the Federal Housing Administration, FHA loans are easier to qualify for than conventional loans.

Unlike conventional loans, you can qualify for an FHA loan with a credit score as low as 500 — with a 10% down payment. With a credit score of at least 580, you can qualify for an FHA loan with a 3.5% down payment.

And, FHA loans offer lower interest rates than conventional loans if you have a lower credit score. So, you’ll pay less over the lifetime of the loan.

Like conventional loans, you need to have a debt-to-income ratio of less than 50%.
But, FHA mortgages do require mortgage insurance (MI) — regardless of the down payment. If you put 10% down, your MI will be canceled after 11 years.
However, if you put less than 10% down, you’re required to have MI for the lifetime of the loan. The only way to get rid of the MI is to refinance your mortgage to a non-FHA loan.

Unlike conventional loans, there are no jumbo FHA loans. If your loan amount exceeds $331,760 in low-cost areas or $765,600 in expensive areas, you won’t qualify for an FHA mortgage.

And, not all properties meet FHA requirements. With an FHA loan, you have to live in the home you buy. So, FHA mortgages require that homes are healthy and safe for you to live in — along will being well constructed. This also means you won’t be able to get an FHA mortgage if the house you want to buy isn’t your primary residence.
FHA loans have low credit and down payment requirements — while still offering good interest rates. If you don’t have great credit, an FHA loan could be the right mortgage for you.

Pros of FHA Mortgage

• Low credit requirements
• Low down payment requirements
• Good interest rates for low credit scores

Cons of FHA Mortgage

• Required MI — even with 20% down
• No jumbo loans
• Must live in the home

VA Mortgage

Another common type of federally insured mortgage is a VA home loan. Established by the GI Bill of 1944, VA mortgages are only available to qualifying military members and spouses.

If you served in the military for the minimum required time, then you can get a VA loan. If you’re a surviving spouse of a KIA, MIA, or POW soldier or one who died from service-related disabilities, then you can get a VA loan.

A VA loan has no minimum credit score. And, there’s no down payment required. Even with a 0% down payment, there’s no MI required. So, if you qualify, you can get a VA loan — even if you have low credit and little savings.

VA loans also have low interest rates and no pre-payment penalty. So, you’ll pay less over the lifetime of your mortgage — while having the option to pay it off early. Plus, VA loans have limited closing costs — so you won’t have many up-front costs.

However, VA loans do have a loan funding fee. Usually, the funding fee falls between 1.4%-3.6% of the purchase price. It’s set by the federal government, so it can change. What you pay is based on your down payment, whether it’s your first VA loan, and other factors.

The funding fee is to cover the cost of foreclosing if you default on your loan. Since the loan is federally insured, you have to pay some of the cost of this insurance. You have the option to pay the loan funding fee upfront or as part of your monthly payment.

Any property you buy with a VA loan needs to be your primary residence. If you want to buy a vacation home or an investment property, you can’t use a VA loan for it.
VA loans offer qualifying service members and spouses an affordable way to buy a home. With no down payment or credit score requirements, a VA loan could be a good option if you qualify.

Pros of VA Loans

• No credit requirements
• No down payment requirements
• Limited closing costs

Cons of VA Loans

• Limited eligibility
• Loan funding fee
• Only for primary residences

USDA Loans

Also federally insured, United States Department of Agriculture (USDA) loans are for rural and suburban buyers. Nearly every rural area qualifies for a USDA mortgage, but only some suburbs meet the requirements.
Created for low income rural/suburban buyers, the USDA loan requires no down payment. And, you can qualify if you have little to no credit history. But if you have a credit score at or above 640, it will expedite the process.

For a USDA loan, your monthly payment can’t exceed more than 29% of your income. And, you need to have a dependable income history to qualify.
With a USDA mortgage, you can get an interest rate of as low as 1% — potentially saving you thousands on a house. USDA loans also cover closing costs. And, USDA loans come with the option for a home improvement grant. This is helpful if you’re looking for a fixer-upper.

Along with locational requirements, USDA loans have an income maximum. To qualify, your household income can’t exceed 115% of the median household income in your area. So, if you exceed these income limits, you won’t be able to get a USDA loan.

Like FHA loans, USDA loans require mortgage insurance. And, USDA loans have property requirements — to ensure the home is safe for you to occupy. You can only use a USDA loan on a home you plan to live in — so investment properties and second homes don’t qualify.

USDA loans have lower credit requirements, a zero down payment, and low interest rates. But with location and income requirements, you might not qualify. If you meet the requirements, a USDA loan can be a good choice if you want to skip a down payment.

Pros of USDA Loans

• No down payment
• Less strict credit requirements
• Low interest rates

Cons of USDA Loans:

• Location and income restrictions
• Required mortgage insurance
• Only for owner-occupied properties

Buying a home is exciting! Getting a mortgage, on the other hand, is about as exciting as getting a root canal. Although it’s necessary to purchase your home, finding the right mortgage for you can be complicated, confusing, and seemingly impossible.

Trying to navigate all the mortgage terms and types can overwhelming. Without understanding which mortgage type is right for you, it’s easy to get stuck in the wrong loan — with a high interest rate, pricey fees, or costly requirements.
But, once you understand the mortgage types (and all the jargon that goes with them), you’re on your way to making a smart mortgage choice (go you!). And, enjoying your awesome new home — instead of being stressed about the wrong mortgage.

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Learn more about how Ribbon can help you get your perfect home today.