5 Types of Mortgage Loans and How To Choose the Best for You

Homeownership is the American dream — and making this dream a reality is something to celebrate! 

But for most people, homeownership is not possible without taking out a mortgage, which means taking on debt.

There are many types of mortgage loans and some will be better suited to you than others. Here’s what you need to know if you’re in the market for a new home. 

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Conventional Loans

Conventional loans are the most popular type of home loan. Banks, credit unions, and mortgage companies offer them directly. 

Conventional loans often require a down payment — usually at least 5%, but sometimes as little as 3%.

If your down payment is less than 20%, private mortgage insurance (PMI) is required. This is an extra cost that will be calculated into your monthly payments. PMI is necessary because a low down payment makes you more of a risk in the lender’s eyes.

PMI can be removed once your loan balance hits 78% of your home’s original value, or you have been paying on your loan for 15 years. Additionally, you can always refinance if the value of your home has increased significantly.

Conventional mortgages also require a higher credit score than government-backed loans — typically a minimum of 620 but for better rates, you need a score of 740+.

But an upside is that conventional loans usually have more competitive interest rates than government-backed loans. 

There are two main types of conventional loans: fixed-rate and adjustable-rate, with terms typically ranging from 15 to 30 years. 

READ MORE: How To Get a Mortgage

Fixed-rate mortgages

• Best for: People who prefer stability and predictability over time, or if interest rates are currently low.

With fixed-rate mortgages, your interest rate remains unchanged throughout the loan term (15, 20, or 30 years, typically.) This makes for easier budgeting as the monthly payment remains unchanged. 

If you escrow your loan (meaning you include your property taxes and insurance in your payment), you may see a small adjustment to your mortgage bill annually, depending on the balance in your escrow account. 

RELATED: How Much House Can I Afford?

Adjustable-rate mortgages

• Best for: People who don’t intend on living in the home long enough for the rate to adjust, or who intend on refinancing at some point. 

With an adjustable-rate mortgage (ARM), the interest rate starts low and remains fixed for an initial period, typically 5, 7, or 10 years. 

At the end of that period, the rate adjusts periodically based on a set index. The rate can increase or decrease depending on current market conditions. 

The adjustable nature of ARMs typically makes them more affordable in the early years, and the rates are generally lower than conventional fixed-rate mortgages. But ARMS can also make budgeting more challenging.

RELATED: Why Did My Mortgage Go Up?

Government-Backed Loans

Government-backed mortgages are insured by a federal agency but are provided by a bank or mortgage lender. They are designed to help borrowers who may not qualify for conventional loans. 

Government-backed loans usually require lower down payments and accept lower credit scores and higher debt-to-income ratios (how much debt you owe compared to your income). 

Since they are backed by the government, they reduce the risk to the lender, which allows for more flexible borrowing requirements. 

There are three main types of government-backed loans: FHA, VA, and USDA.

FHA loans

• Best for: First-time buyers or credit-challenged individuals. 

FHA loans are insured by the Federal Housing Administration and target low- to moderate-income borrowers. They are also ideal for first-time homebuyers who don’t have as much cash or an established credit score. 

The down payment required is a minimum of 3.5% and in some circumstances, you can qualify with a credit score as low as 580. The debt-to-income ratio is also higher, sometimes up to 50%.  

A big downside to FHA loans is they require a mortgage insurance premium (MIP). Unlike PMI, this mortgage insurance never falls off and is required regardless of down payment size. 

You also have to pay upfront MIP with your closing costs, which is usually around 1.75% of the loan. 

VA loans 

• Best for: Active or former military service members, and in some situations can be used by their spouses, children, or parents. 

A VA loan is offered by private lenders but is backed by the U.S. Department of Veterans Affairs (VA). They are specifically for eligible military service members, including veterans and their immediate families.

Perks of VA loans include no down payment requirement, competitive interest rates, and no PMI.

The credit score requirement is also flexible, ranging from as low as 500 to a minimum of 620.

Eligibility for a VA loan varies depending on things like length and type of service. The VA also provides entitlement, which is an amount of money guaranteed to the lender that provides your loan should you default.

USDA loans 

• Best for: Those seeking to buy a home outside of a city and who may benefit from the $0 down payment. 

The US Department of Agriculture offers the USDA loan program to promote homeownership in rural and select suburban areas. 

USDA loans offer huge advantages for low- to moderate-income borrowers, like a $0 down payment requirement and competitive interest rates.

Typically, a minimum credit score of 620 is required and you must meet specific income limits based on the location of the home and household size. 

READ MORE: How To Buy a Home With No Down Payment

Jumbo Loans

• Best for: Borrowers who need to finance luxury homes or buy a property in a high-cost area that would typically merit the need to borrow multiple loans. 

Conventional loans typically have to meet borrowing limits that are set by the Federal Housing Finance Agency (FHFA). If you’re buying a property that costs more than that limit, you can look at a jumbo loan.

Limits vary by location but are higher in more expensive housing markets, like in parts of California, for example. 

Since jumbo loans are larger, they are riskier for lenders. They often require higher credit scores, larger down payments, and stricter financial qualifications.

Jumbo loans also have higher interest rates than conventional conforming loans. 

Home Equity Loans and Lines of Credit

• Best for: People who have a lot of equity in their home and need to fund home improvements, consolidate debt, or pay off major expenses.

Home equity lines of credit (HELOCs) and home equity loans (HELOANs) are commonly known as a “second mortgage.” 

Both let you borrow money by using the equity in your home as collateral. They’re typically used for home repairs or upgrades or for covering unexpected life expenses. 

• A HELOAN is a one-time lump sum, typically with a fixed interest rate. 
• A HELOC is a revolving line of credit that you can draw from as needed (with limitations). The interest rates are typically variable, and you usually only pay interest on the amount you draw. 

After the loan matures or the draw period ends, you have to pay back the entire outstanding balance.

They usually come with annual fees, however, the interest rates are often lower than rates on other types of loans and credit cards.  

Reverse Mortgages 

• Best for: Retirees who need to supplement retirement income — but it’s important to know that these loans also reduce home equity and can impact inheritance. 

A reverse mortgage is a special mortgage available to senior homeowners age 62 or older. It allows you to convert a portion of your home equity into cash. 

The difference from regular mortgages is that reverse mortgages don’t require monthly payments. Instead, the loan balance increases over time as fees and interest pile up. 

The loan is usually repaid when the homeowner sells the home, refinances, changes permanent residence, or passes away. 

Reverse mortgages are typically backed by the FHA (Federal Housing Association) and are in the form of the Home Equity Conversion Mortgage (HECM).

RELATED: How To Save for Retirement

FAQs

What is the best type of loan to get for a house? 

The best type of mortgage depends on your situation. Mortgage loans depend on your financial situation, employment history, credit score, and down payment ability, so they aren’t one-size-fits-all. 

That said, conventional loans are often the cheapest and most flexible option. FHA loans are good if you have a low credit score or can only afford a small down payment, while VA and USDA loans are good for veterans and those in rural areas. 

What's the best type of mortgage for first-time buyers?

Whatever loan you can qualify for may be the best for a first-time homebuyer. That said, FHA loans are a common choice since first-time buyers tend to not have an established credit history and may not have as much cash to put down. 

Who are Fannie and Freddie?

Both Fannie and Freddie are corporations that buy mortgages from banks. Banks refer to these loans as “secondary market,” meaning the loans are sold off to these corporations to help create more cash flow. 

• Fannie Mae is short for the Federal National Mortgage Association. Fannie was crafted by the U.S. Congress during the Great Depression to ease the lack of affordable housing. 
• Freddie Mac is short for the Federal Home Mortgage Loan Corporation and exists to offer an alternative to Fannie. 

Both Fannie and Freddie are almost always conventional loans and are considered “conforming,” meaning they follow certain borrowing limits set by the FHFA. 

TL;DR: Which Mortgage Loan Should I Get?

There are many types of mortgages, each dependent on your financial situation and other factors such as your credit score, how much money you can put down, and your debt-to-income ratio.

For most people, conventional loans or government-backed loans will be your solution. But more unique options, like jumbo loans, HELOCs, and reverse mortgages also exist for certain situations. 

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