June 25, 2018
June 25, 2018
While it’s common to use the term “mortgage” as if it’s a single type of financial product, there are several different variations. Each provides basic home financing but with its features and nuances. You may find one loan type preferable to another, either based on personal circumstances or financial goals.
Let’s take a look at the different major types of mortgages, and the pros and cons of each.
These mortgages are called conventional to distinguish them from government loans, like FHA, the Federal Housing Administration, and VA, or Veterans Affairs, mortgages. The loans themselves are funded by the Federal National Mortgage Association (FNMA, or “Fannie Mae”) and the Federal Home Loan Mortgage Corporation (FHLMC, or “Freddie Mac”).
But perhaps what most differentiates conventional mortgages from government mortgages is the source of private mortgage insurance (PMI). While the PMI on FHA and VA loans is provided by government sources, it comes from private insurance companies on conventional mortgages.
PMI is required any time you either make a down payment of less than 20% of the purchase price on a home or have less than 20% equity in the case of a refinance.
Let’s look at the pros and cons of conventional mortgages:
These are mortgages that are insured by the Federal Housing Administration or FHA. The agency was created during the Great Depression to both standardize and liberalize mortgage financing. Over the years, FHA has made more generous loans to less qualified borrowers.
FHA mortgages are available in both fixed rate and adjustable. Terms can be from 15 years to 30 years.
All three of the major mortgage types offer both fixed-rate loans and adjustable rate mortgages, called ARMs. Fixed rates range from as little as 10 years up to 30 years. And naturally, 30-year loans are the most popular.
ARMs are typically for 30 years. They offer a fixed term for a limited amount of time, then the rate will periodically adjust to a new rate based on the market rate index. On FHA and VA mortgages, an ARM has a fixed term of five years, then converts to a one-year adjustable over the balance of the loan.
Conventional mortgages offer initial fixed terms of three, five, seven and 10 years. After the initial term, they also become one-year adjustable-rate loans over the balance of the loan term.
For this reason, ARM loans are frequently referred to as 3/1, 5/1, 7/1 or 10/1 in the industry.
ARMs typically have what is known as “rate caps”. For example, the initial rate adjustment may be limited to 2%. That means an initial rate of 3.5% cannot exceed 5.5% on the first adjustment. A 2% cap on subsequent adjustments is also typical. There’s also a lifetime cap of 5%, which would limit an initial rate of 3.5% to no more than 8.5% over the life of the loan.
Since fixed-rate mortgages are self-explanatory, let’s focus on the pros and cons of the ARMs.
The mortgage industry has come a long way over the years. There are different mortgage types and specializations depending upon your particular circumstances and what it is you would like to do. For example, a VA loan provides many benefits for an owner-occupied property. But they don’t offer loans for vacation homes. That’s where a conventional mortgage becomes a better option.
If you have some credit issues, FHA mortgages tend to be the most accommodating. If you plan on staying in your home for life, you’ll favorite a fixed-rate 30-year mortgage, over a five-year ARM.
The good news is, wherever you are financially, and whatever your goals may be, the right loan exists. Choose the mortgage type that works best for you.
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