Since very few people can afford to simply pay cash for a home, it is usually necessary to borrow money ― this is where a mortgage loan comes in. A mortgage lender provides you with the up-front capital you need to make the home purchase, and then you repay the lender (with interest) over a period of time.
However, it’s important to understand that not all mortgage loans are created equal. Listed here are some of the variations you are likely to see while you shop around for a home mortgage loan.
Conventional Mortgage: A conventional mortgage loan is basically any loan that is not insured or guaranteed by the federal government. Conventional loans are generally referred to as “standard” loans, as opposed to government-backed loans and other home financing alternatives. Although conventional loans are not government-insured, they can still conform to GSE (Fannie Mae and Freddie Mac) guidelines. Any mortgage loan that does not meet GSE guidelines, or goes over the conforming loan limit, is considered non-conforming.
Fixed-Rate Mortgage: A fixed-rate mortgage loan maintains the same interest rate throughout the life of the loan. The mortgage rate does not change, meaning that borrowers will have the security of predictable monthly mortgage payment amounts.
Variable-Rate Mortgage: If you obtain a variable-rate mortgage loan (also known as an “adjustable-rate mortgage”), the interest rate will fluctuate periodically based on a predetermined market index. This means that your mortgage payments can vary (sometimes significantly) each time the interest rate “adjusts.” This type of mortgage loan allows the lender to share the risk of rising rates with the borrower.
Interest-Only Mortgage: With this type of mortgage loan, you can pay only interest for a set period of time. After that, the payments will adjust to include both principal and interest for the rest of the loan term. This results in small monthly payments during the early years, but bigger payments later on.
Jumbo Mortgage: A mortgage loan that is non-conforming because it exceeds the purchasing limits (set by the housing GSEs, Fannie Mae and Freddie Mac) is called a “jumbo” mortgage. Since jumbo mortgages are too big to be bought and repackaged by the GSEs, any lender that issues a jumbo mortgage loan must hold onto the debt themselves. This, plus the larger-than-average loan amount, creates huge risk for the lender. (Note that GSE purchasing limits can vary by state and number of units.)
FHA Mortgage: FHA loans are managed by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development (HUD). The FHA does not issue loans ― it provides mortgage insurance on loans made by FHA-approved lenders, protecting them against losses in case the borrowers fail to repay their debts.
VA Mortgage: If you are a veteran, you could be eligible for a VA mortgage loan. VA loans are backed, not issued, by the federal government. VA loans are made by qualified lenders, and guaranteed by the U.S. Department of Veterans Affairs. VA-backed loans are designed specifically for veterans, active duty personnel, Reservists/National Guard members, and qualified surviving spouses.
In addition to these basic and common types of mortgage loans, there are a variety of other home financing options. Many states and localities feature special mortgage loan programs, including loans for first-time homebuyers and loans for home improvements. Before deciding which mortgage loan is best for you, it’s a good idea to carefully consider your personal situation and understand the pros and cons of each type of mortgage loan.