A Guide to the 5 Types of Real Estate Loans

Are you in the market for a new home? Are you looking for ways to finance it? If so, then you may be interested in learning about the different types of real estate loans or mortgages available. 

Whether you are a first-time homebuyer or have owned several homes before, understanding the various home loan options can help you make the best decision for your financial future. In this article, we will explore the different types of mortgages and discuss their advantages and disadvantages so that you can find the right fit for your needs.

A Conventional Mortgage

A conventional mortgage is the most common type of loan used to buy or refinance a home – hence the name. Conventional mortgage loans are offered by private mortgage lenders and are not insured by the government or some other entity, which separates them from some other types of real estate loans.

To qualify for a conventional mortgage, you typically need a good credit score and a stable financial situation. Lenders also look at factors like your income, debt-to-income ratio, and employment history. Each lender has a specific set of requirements for qualification.

There are two main types of conventional mortgages:

• conforming
• non-conforming loans

Conforming loans meet the guidelines set by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. They have loan limits and other requirements. Non-conforming loans, on the other hand, do not meet these guidelines but may have higher interest rates.

One advantage of conventional mortgages is that they offer flexibility and a wide range of loan options. You can choose between fixed-rate or adjustable-rate mortgages, and you have more choices in terms of lenders. The interest rates for conventional mortgages are often competitive.

However, there are also some downsides to conventional mortgages. They generally require a higher credit score and a larger down payment compared to government-backed loans. You may also need to pay private mortgage insurance (PMI) if your down payment is less than 20% of the purchase price.

In summary, conventional mortgages are a popular choice for those who have good credit and a stable financial situation. They offer flexibility and a variety of loan options, but they can also have stricter requirements and additional costs.

Government-Backed Housing Loans

Government-backed housing loans are types of real estate loans that are supported and insured by the federal government, i.e. the government protects lenders in case a borrower defaults on their mortgage payments. These loans are designed to make homeownership more accessible and affordable for people who may not qualify for traditional loans.

There are several types of government-backed loans, including Federal Housing Administration (FHA) loans, Department of Veterans Affairs (VA) loans, and United States Department of Agriculture (USDA) loans.

FHA Mortgage

FHA mortgages are loans that are insured by the Federal Housing Administration. One of the benefits of an FHA mortgage is that it allows borrowers to make a lower down payment, usually as low as 3.5% of the purchase price.

This can be helpful for individuals who may not have a large amount of savings for a down payment. So, if the purchase price of a home is $300,000, you would only need to have $10,500 as a down payment, which is much less than what you would need to pay if you got a conventional mortgage.

In addition to the lower down payment requirement, FHA mortgages also have more lenient credit score requirements compared to conventional loans. The minimum credit score required for an FHA mortgage is often around 580, whereas conventional loans typically require you to have a credit score of at least 620, and even then you would likely get high interest rates and need to pay PMI.

To be eligible for an FHA mortgage, borrowers must have a steady income that can support the monthly mortgage payment. Additionally, they must also be able to demonstrate that they have a responsible financial history. This includes a track record of paying bills on time and managing credit responsibly.

USDA Mortgage

USDA mortgages are loans insured by the United States Department of Agriculture. These loans are designed to help low- to moderate-income individuals and families purchase or refinance their homes in rural areas.

To be eligible for a USDA mortgage, you must meet certain criteria. First, the property you wish to purchase or refinance must be located in a designated rural area as determined by the USDA. Additionally, your income cannot exceed a certain limit based on the size of your household and the area in which you live.

One of the key benefits of a USDA mortgage is that it requires no down payment. This means that eligible borrowers can finance 100% of the purchase price of the home. Another advantage is that USDA mortgages typically come with lower interest rates compared to conventional loans, making them more affordable.

USDA mortgages also offer longer repayment terms, up to 30 years, which can result in lower monthly payments. These loans can be used to purchase both primary residences and certain types of investment properties, such as rental homes.

VA Mortgage

VA mortgages are home loans that are insured by the Department of Veterans Affairs. These loans are specifically designed for veterans, active-duty service members, and surviving spouses of service members who meet certain eligibility requirements.

With a VA mortgage, eligible individuals can take advantage of several benefits. First, these loans typically do not require a down payment, allowing borrowers to purchase a home without having to save a large sum of money upfront. Additionally, VA mortgages often have competitive interest rates, making homeownership more affordable for veterans and their families.

One unique feature of VA mortgages is that they do not require private mortgage insurance (PMI), which is typically required for conventional home loans with a down payment of less than 20%. This can save borrowers a significant amount of money in monthly payments.

VA mortgages also offer flexible qualification standards, taking into account factors other than just credit scores, such as income ratios and the borrower's financial situation. Additionally, VA loans have no maximum loan limits, allowing borrowers to finance higher-priced properties.

Jumbo Loans

Jumbo loans are a type of real estate loan offered by private lenders that is larger than the loan limits set by the federal government for conventional loans. As such, they are often used to buy luxury, high-end investment, or commercial properties. Average homeowners typically do not need to get jumbo loans.

Lenders of jumbo loans often offer competitive interest rates, similar to conventional loans. Jumbo loans also provide flexibility in terms of loan options, such as adjustable rates or fixed-rate mortgages.

But getting a jumbo loan comes with strict qualification requirements:

• Requires a higher minimum credit score compared to conventional loans.
• Typically comes with stricter income ratios and documentation requirements.
• Often involves higher down payment requirements, usually around 20% or more.
• May have higher closing costs and fees compared to conventional loans.

In short, jumbo loans are a financing option for purchasing high-priced properties that exceed the limits of conventional loans. While they offer flexibility and competitive interest rates, they also come with stricter requirements and higher costs.

Fixed-Rate vs. Adjustable-Rate Mortgages

Conventional mortgages, government-backed loans, and jumbo loans are different types of real estate loans that serve specific purposes and have certain qualification standards. But there is an additional, key factor you need to consider when getting a home loan - whether you wish to get a fixed-rate or adjustable-rate mortgage.

Fixed-Rate Mortgages

Fixed-rate mortgages are a common type of mortgage loan used for purchasing real estate. With a fixed-rate mortgage, the interest rate remains the same for the entire duration of the loan, which is typically 15 or 30 years.

Fixed-rate mortgages have several advantages:

• Predictable monthly payments: With a fixed-rate mortgage, your monthly payment stays the same throughout the loan term. This makes budgeting easier and provides stability.
• Protection against rising interest rates: If interest rates increase in the future, your fixed-rate mortgage will remain unaffected, providing you with long-term savings.

But also potential disadvantages:

• Potentially higher initial interest rate: The initial interest rate on a fixed-rate mortgage may be higher compared to adjustable-rate mortgages.
• Limited flexibility: Unlike adjustable-rate mortgages, you cannot take advantage of lower interest rates if they decrease in the market.
• Potential higher overall interest payments: Since the interest rate remains constant, you may end up paying more interest over the life of the loan compared to adjustable-rate mortgages if market rates decrease.

Adjustable-Rate Mortgages (ARMs)

Adjustable-rate mortgages (ARMs) are a type of real estate loan where the interest rate changes over time. You have a fixed period and an adjusted period. During the fixed period, which you negotiate with your lender when you are getting your mortgage, your interest rate stays the same.

During the adjusted period, the interest rate changes based on certain benchmarks or an index – the typical index for ARMS since 2020 is SOFR. The initial interest rate is usually lower than fixed-rate mortgages, making the monthly payment more affordable in the beginning.

For example, let's say you have an ARM with a starting interest rate of 3%. Your monthly payment would be lower compared to a fixed-rate mortgage with a 4% interest rate. After a certain period, typically 5 or 7 years, the interest rate adjusts based on market rates.

So if the market rates increase to 5%, your ARM's interest rate will also increase accordingly and be higher than what you would pay for a comparable fixed-rate loan. On the other hand, the reverse can also happen and your interest rates could go down. We should also note that the interest rates on ARMs are capped, that is, there is a limit to the maximum interest rate you may need to pay.

Here are some pros of adjustable-rate mortgages:

• Lower initial interest rates can save you money in the beginning.
• Good for short-term homeowners or those expecting income to increase in the future.
• Can be beneficial if you plan to sell the property before the rate adjustment period.

But also some cons::

• Monthly payments can increase significantly after the rate adjustment.
• Uncertainty about future interest rate changes.
• Not ideal for long-term homeowners or those on a fixed budget.

In summary, adjustable-rate mortgages provide flexibility and lower initial payments, but they come with the risk of increasing rates in the future. Consider your financial situation and long-term goals when deciding on a mortgage option.

Utilizing Escrow to Buy Property

If you are reading about the different types of real estate loans because you plan to buy a home, we can help after you have made up your mind and chosen a house to buy. Lightspeed Escrow was founded by real estate experts to make the process of buying a home as simple as possible.

Closing on a home can be an arduous process, in part because of the bureaucracy involved. We can assist you in closing quickly and without hassle. Our fast and accurate escrow services will help your real estate transaction go smoothly. If you wish to learn more about how our escrow process works, feel free to contact us and we will answer any questions you have.