Buying a Home 101: Types of Loans

Types of Loans

1. Conventional Loan - Best for borrowers with a good credit score

2. Jumbo Loan - Best for borrowers with excellent credit who want to buy a more expensive home. 

3. FHA - Backed by the Federal Housing Administration, this loan is best for borrowers with low to moderate income. 

4. VA - Back by the U.S. Department of Veteran Affairs, this loan is available to current and past members of the U.S. Military.

CONVENTIONAL LOANS

Conventional Loans are not backed by the federal government, and they come in two packages: conforming and non-conforming. As the name implies, conforming loans comply with the standards put in place by the Federal Housing Finance Agency (FHFA), which includes credit, debit, and loan size. In 2022, the conforming loan limits in most areas are $647, 200. 

Non-conforming loans so not meet FHFA standards. These loans may be for larger loans, or they might be offered to borrowers with subpar credit or who have experienced serious financial hardship such as bankruptcy.

Pros of Conventional Loans

• Can be used for a primary home, second home or investment property

• Overall borrowing costs tend to be lower than other types of mortgages, even if interest rates are slightly higher

• Can ask your lender to cancel private mortgage insurance (PMI) once you’ve reached 20 percent equity, or refinance to remove it

• Can pay as little as 3 percent down on loans backed by Fannie Mae or Freddie Mac

• Sellers can contribute to closing costs

Cons of Conventional Loans

• Minimum FICO score of 620 or higher often required (the same applies for refinancing)

• Higher down payment than some government loans

• Must have a debt-to-income (DTI) ratio of no more than 43 percent (50 percent in some instances)

• Likely need to pay PMI if your down payment is less than 20 percent of the sales price

• Significant documentation required to verify income, assets, down payment and employment

JUMBO LOANS

As the name implies, Jumbo loans fall outside of the FHFA limits. Jumbo loans are more common in higher priced areas, where home prices exceed the conforming limits. 

Pros of Jumbo Loans

• Can borrow more money to buy a more expensive home

• Interest rates tend to be competitive with other conventional loans

Cons of Jumbo Loans

• Down payment of at least 10 percent to 20 percent needed

• A FICO score of 700 or higher typically required

• Cannot have a DTI ratio above 45 percent

• Must show you have significant assets in cash or savings accounts

• Usually require more in-depth documentation to qualify

FHA LOANS

Backed by the FHA, these types of home loans help make homeownership possible for borrowers without a large down payment or perfect credit. Borrowers need a minimum FICO score of 580 to get the FHA maximum of 96.5 percent financing with a 3.5 percent down payment; however, a score of 500 is accepted if you put at least 10 percent down. FHA loans require two mortgage insurance premiums, which can increase the overall cost of your mortgage. Lastly, with an FHA loan, the home seller is allowed to contribute to closing costs.

Pros of FHA Loans: 

• Help you finance a home when you don’t qualify for a conventional loan

• Credit requirements more relaxed

• Don’t need a large down payment

• Available to repeat and first-time buyers

Cons of FHA Loans (government-insured loans)

• Mandatory mortgage insurance premiums on FHA loans that cannot be canceled unless refinancing into a conventional mortgage

• Loan limits on FHA loans are lower than conventional mortgages in most areas, limiting potential inventory to choose from

• Borrower must live in the property (although you may be able to finance a multi-unit building and rent out other units)

• Could have higher overall borrowing costs

• Expect to provide more documentation, depending on the loan type, to prove eligibility

VA LOANS

For military service members, veterans and eligible spouses, VA-backed loans are often better than a conventional loan. These loans are backed by the Department of Veterans Affairs. Created as part of the G.I. Bill in 1944, VA loans are available to current and past members of the U.S. military. VA loans don’t require a down payment nor mortgage insurance. Certain veterans are exempt from standard VA closing costs.