Types of mortgage loans

What are the options for mortgage loans?

When it comes to mortgage loan options, there are several decisions you will need to make about how you want to repay your loan, including your term length and the type of rate (fixed or variable). Additionally, if you buy property that doesn’t fit under specific guidelines, you will need to use a nonconforming loan.

There is no right or wrong choice, since all options come with their own advantages and disadvantages.

Conventional loans

Banks and other lenders offer conventional mortgage loans, which aren’t backed by the government. They’re classified as either conforming or nonconforming, depending on whether they conform to federal mortgage loan limits and terms set by the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac.

With a conventional loan, buyers have the option to borrow more money and get more flexible mortgage terms than government-backed mortgages. These loans are harder to qualify for than government loans, since they require higher credit scores and lower debt-to-income (DTI) ratios.

There are several types of conventional loans programs buyers can consider in addition to traditional ones:

• Conventional 97: Conventional 97 loans are offered by Fannie Mae to first-time homebuyers for an amount up to 97% of the property value. To qualify for a conventional 97 mortgage, the property must be a single-unit home that will be used primarily as a residence. Conventional 97 loans have fixed rates and carry a term of up to 30 years. Buyers will also have to take a homeowners education course.
• HomeReady: Offered by Fannie Mae to low- and moderate-income buyers who need to buy or refinance a home, HomeReady offers a lower down payment and borrower contribution, more affordable mortgage premiums and a flexible approval process. It allows family members or friends to co-sign on your loan and considers income from other household members for approval. To qualify, you must meet an income limit requirement, typically equal to or less than the area median income. You need a minimum credit score of 620. Homeownership education is required.
• Home Possible and Home Possible Advantage: Offered by Freddie Mac to low- and moderate-income borrowers, these loans are for one- to four-unit homes, condos, planned unit development homes (PUD) and manufactured homes. These mortgages require a 3% down payment and credit scores as low as 660. It also has fixed or adjustable rates and carries a term of up to 30 years. They differ in the properties they finance, rate pricing adjustments, loan-to-value ratio (LTV) for each property and loan amounts.

Whom it’s best for:

Conventional mortgages are usually best for prospective homebuyers with a strong credit history, stable income and the ability to make a down payment of at least 5%. Conventional mortgage loans can be used to finance a primary residence, secondary home or investment property.

Government-backed loans

When a government agency, such as the Federal Housing Administration (FHA), Department of Veterans Affairs (VA) or the Department of Agriculture (USDA), insures a home loan that is issued by a private lender, that mortgage is considered a government or government-backed loan. All government-backed loans are within maximum conforming loan limits, which is $726,200 in most areas (up to $1,089,300 in high-cost areas) for 2023.

The downside is that even though you might secure a better rate for your current financial situation, government-backed mortgage loans have stricter property guidelines and higher fees. Not everyone will qualify, and even if you do, your home choice will have to fit specific conditions and price standards.

Whom it’s best for:

If you have low to moderate income or a less-than-great credit score, government-backed mortgages are typically easier to qualify for than conventional mortgage loans. FHA, VA and USDA loans have more relaxed lending guidelines and payment terms and might not require a down payment.

Nonconforming loans

Nonconforming loans generally require larger down payments and come with higher mortgage interest rates than conforming loans. However, you can borrow a larger amount than with a conforming loan.

Jumbo loans, a type of nonconforming mortgage, are for amounts higher than the limits set by the FHFA. Currently, loans for greater than the conforming jumbo limit in a given county are considered nonconforming “jumbo” loans.

There are also super jumbo loans, which are intended for buyers who want to acquire bigger and more expensive homes. The loan limits are higher than those of jumbo loans and carry fixed or adjustable rates. The down payment normally ranges between 10% and 20%. To qualify, borrowers must have large incomes and assets, excellent credit history and low DTI ratios.

These loans are issued by private jumbo lenders, such as banks and other financial institutions. The private lenders set their own rules on requirements and approval and typically hold the loans as investments.

Note that while jumbo loans still can have competitive interest rates and loan term options like a conventional loan, you can expect a higher down payment requirement and higher closing costs and fees. Jumbo loans are harder to qualify for than conventional loans due to their stricter credit requirements.

Whom it’s best for:

Jumbo (nonconforming) mortgages are best for those who want to buy a really expensive house and have the credit score to qualify. Generally, nonconforming loans are best for high-income homebuyers who want to borrow above the limits of conforming loans and are willing to make a larger down payment.

» MORE: What is a jumbo loan and am I eligible?

Other types of mortgages

Not all mortgage types fit neatly into the conventional or government-backed mortgage category. These other loans are suitable for buyers who need additional funds to renovate at the time of purchase, as well as current homeowners who want to tap into their equity or change their terms.

» MORE: Reverse mortgage vs. home equity loan vs. HELOC.

How to compare the different types of mortgage loans

When trying to choose a mortgage, start by comparing the interest rates and fees for each loan. Lower interest rates are better, since they mean you'll pay less money in interest over the life of the loan, but don’t rely on interest rates alone to tell you if you are getting a good deal — review the annual percentage rate (APR), which includes all fees. For example, if you choose a USDA loan, you will be tied to an additional 1% closing fee and 0.35% annual fee.

Another thing to consider before choosing your mortgage type is where you are financially as a buyer. Do you have an excellent credit score and a generous-sized down payment? A conventional loan will most likely give you the best rate and allow you to have more freedom in house choice. However, if your credit score is not the best or you don’t have more than 5% saved, a government-backed loan can help you still accomplish your homeownership goals.

Reaching out to a lender will give you a better understanding of which loan types are right for your finances and housing needs, as well as any issues you need to address before applying for preapproval.

Bottom line

Understanding the different types of mortgage loans available is an important early step in choosing the best home loan for you or your family. The best type of mortgage for you will depend on factors like your credit score, income level and loan term preferences. Comparing multiple lenders will ensure you get the best terms on your home loan.