What Type of Mortgage Loan Is Best for You?

by Tammy Logston, Contributor

In determining what type of mortgage loan is best for you, it is wise to know which mortgage loans are available to you.  First, know that the type of loan and the type of mortgage is different.  Sound advice is to know your financial situation and what mortgage loan/program you are qualified for.

In today’s market, there are several types of loans and mortgages. Your approval will depend on your financial status, the amount of money you have available for a down payment, your credit history, and even your military history (if applicable).

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The following information describes the most common types of LOANS, as well as advice about their key features and restrictions:

Conventional Loans
Conventional mortgage loans usually require a minimum 5%-20% down payment, a 36% front-end ratio, and a 28% back-end ratio. As general mortgage advice, conventional loans do not have amount limits, and they usually come with lower mortgage insurance charges than government-backed loans. Conventional loans may require a stronger credit score (720 or higher for good interest rates) and are more stringent on borrowers with a bankruptcy in their credit history (compared to government-backed mortgages).

FHA Loans
FHA mortgage loans are government-backed. An FHA loan requires a minimum 3.5% down payment, which means that eligible borrowers can get financing for up to 96.5%. As a bit of mortgage advice, note that there are maximum loan limits which generally vary according to state, metropolitan area, and/or county, as well as type of dwelling. FHA loans require debt-to-income ratios of 31% (front-end ratio) and 43% (back-end ratio), and a credit score of 620 or higher. Keep in mind, you will also be charged an annual premium for your FHA loan. For additional advice, see the U.S. Department of Housing and Urban Development (HUD) website, or the Federal Housing Administration (FHA) homepage.

VA Loans
VA loans are a government-backed program available to Veterans and Armed Services members, as well as their qualifying widows/widowers. VA loans do not require a down payment or private mortgage insurance, though you must have suitable credit and sufficient income to qualify. You must also obtain a Certificate of Eligibility (COE). While there is technically no limit on how much you can borrow with a VA loan, there is a limit on how much liability the VA will assume (which can impact the amount of money a financial instituation will lend you). Each qualified Veteran is provided a basic entitlement of $36,000 — most lenders will finance up to 4 times a Veteran's entitlement without requiring a down payment. For more information, please visit the U.S. Department of Veterans Affairs website.

USDA Rural Loans (Direct or Guaranteed)
USDA loans are also government-backed, and available for home purchases in rural areas. USDA Direct loans are designed for borrowers with very low- to low-income, who earn between 50-80% of the Area Median Income (AMI). USDA Guaranteed loans can be used by borrowers with income levels up to 115% of the AMI and do not require a down payment. The Rural Housing Guaranteed Loan has flexible credit guidelines, but requires a 29% "front-end" debt-to-income ratio and a 41% "back-end" debt-to-income ratio. To learn more, go to the U.S. Department of Agriculture website.

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The following information describes the most common types of MORTGAGES, as well as advice about their key features and restrictions:

Fixed-Rate Mortgage
With a fixed-rate mortgage, your interest and mortgage payments remain “fixed” throughout the life of the loan (typical loan life is 15 or 30 years).  Payments are higher on a 15-year loan, but if you can afford it, your mortgage will be paid off twice as quickly and you’ll save more than half the interest costs!  As an additional piece of mortgage advice, you may have the option to repay a 30-year loan on a bi-weekly basis (rather than once a month), which can save you time and money.

Adjustable-Rate Mortgage (ARM)
The interest rate on an adjustable-rate mortgage fluctuates during the entire life of the loan.  Your interest rate is modified based on a predetermined economic index and a set margin, both established at the onset of the loan.  Additionally, a cap is usually implemented to prevent enormous increases in the interest rate. Most mortgage advice will tell you to only get an ARM if you’re confident that your budget can handle the fluctuating payments.

Payment-Option ARM
Within the adjustable-rate mortgage family, there are several different variations. This includes the payment-option ARM, which provides the borrower with payment alternatives to accommodate fluctuating cash flow ― these include minimum payment options and interest-only payment options, among others.  As a bit of mortgage advice, it is wise to thoroughly understand these types of loans because you will need to be prepared for a possible sudden increase (payment shock).

Balloon Mortgage
This is a short-term fixed mortgage. At the end of a balloon mortgage, the borrower must pay the remaining balance in a lump sum or refinance their loan.  A common application for the balloon mortgage is when a homebuyer purchases unimproved property that he/she plans to build on within 5 to 7 years.

READ: What Kind of Borrower Are You?