1. Conventional Loans

Conventional loans are the most common type of mortgage. They are not insured by a government agency and are typically offered by private lenders, like banks, credit unions, or mortgage companies.

Conventional loans follow the guidelines set by Fannie Mae and Freddie Mac, the two government-sponsored enterprises that buy and guarantee mortgages. They usually require a credit score of at least 680 (some lenders will go as low as 620) and a down payment of 5, 10, or 20%.

A higher credit score can lead to more favorable interest rates. Even a small reduction of 0.25% to 0.5% in your interest rate can result in significant savings over the life of a loan. For instance, consider a 30-year fixed-rate loan of $500,000 with a 6.5% interest rate equating to a $3,160 monthly payment. Lowering your interest rate by just 0.25% could save you $81 per month or over $29,000 over the term of the loan, while a 0.5% reduction could save you $162 per month or over $58,00 over the length of the loan. Optimize your credit score for better financial outcomes.

Pros and Cons

One major advantage of conventional loans is their flexibility. Without the constraints of government regulations, lenders can offer various terms and conditions to fit your financial situation. However, the downside is the necessity for good credit and some down payment. It is a myth that you need 20% down but that will often get you the best rate.

Conventional loans are ideal for buyers with a stable income and strong credit history. If you can afford a larger down payment, this loan type will likely offer the best interest rates and terms.

The difference between conventional loans and government loans

Government loans come with the assurance of federal backing, providing lenders with protection if a borrower defaults on their mortgage. This security empowers lenders to offer financing to individuals who might not qualify for conventional loans. With government-backed loans, borrowers benefit from more flexible terms, such as smaller or no down payments and lower interest rates for those who meet the criteria. By choosing these options, borrowers can enjoy the advantages of accessible lending and favorable conditions.

The most prevalent government-backed loans for borrowers are FHA loans, favored by first-time home buyers; VA loans, designed for military service members and veterans; and USDA loans, aimed at low-income buyers in rural areas.

2. FHA Loans

FHA loans, insured by the Federal Housing Administration, are designed to help home buyers with lower credit scores and/or a minimum down payment. A borrower doesn't go directly to the FHA to obtain the loan. Rather they would still go through a bank, credit union, mortgage company, or other financial institution.

This loan program allows buyers to make a down payment as low as 3.5% if their credit score is 580 or higher. FHA loans are more accessible for those who may not qualify for a conventional loan.

Pros and Cons

The primary benefit of an FHA loan is its accessibility. Lower down payment requirements and more lenient credit scores make it easier for first-time buyers to enter the housing market. However, FHA loans require both an upfront mortgage insurance premium and monthly mortgage insurance payments, which can add up over time.

FHA loans may not be suitable for every borrower. They are designated for homes that will serve as your primary residence and have borrowing limits. Unlike other government-backed home loans, FHA loans require borrowers to pay a Mortgage Insurance Premium (MIP) throughout the loan's duration, unless a 10% or larger down payment is made, which can reduce this period to 11 years. MIP increases both the closing costs and the ongoing monthly payments. At closing, you'll pay 1.75% of the purchase price, followed by an annual charge of 0.5% to 0.75% of the purchase price, divided into 12 monthly payments.

Who It Suits

FHA loans are perfect for first-time buyers, individuals with a lower credit score, or those who have less saved for a down payment. They offer a pathway to homeownership when conventional loans are out of reach.

3. VA Loans

VA loans are a great benefit for veterans, active-duty service members, and certain members of the National Guard and Reserves. The program aims to offer lifelong benefits to individuals who have served the United States, making homeownership more affordable. VA loans facilitate the purchase, construction, or refinancing of a primary residence.

Backed by the Department of Veterans Affairs, VA loans offer favorable terms and conditions, often without requiring a down payment or mortgage insurance. VA loans are specifically tailored for veterans and active military personnel. If you fall into this category, a VA loan is likely your best option, offering financial flexibility and savings.

Pros and Cons

The biggest advantage of a VA loan is the lack of a down payment requirement and the absence of mortgage insurance, which can make home buying significantly more affordable. 

The biggest drawback is that borrowers are required to pay a funding fee to support the program. For VA loans, this one-time fee is due at closing and ranges from 0.5% to 3.6% of the loan amount. Alternatively, the fee can be added to the total financed amount and paid over the loan's duration. Importantly, some veterans with service-related disabilities may be eligible for a partial or full waiver of this fee.

4. USDA Loans 

USDA loans, supported by the United States Department of Agriculture, offer an incredible opportunity for individuals and families with low to moderate incomes to finance rural housing development. These loans are designed to make dreams of homeownership a reality, especially in areas that need it most.

Pros and Cons

The standout benefit of USDA loans is the ability to finance a home with no money down. Additionally, the interest rates are usually competitive. On the flip side, USDA loans are only available in designated rural areas and come with income limitations.

Who It Suits

USDA loans are ideal for families looking to buy in rural or suburban regions who also meet specific income requirements. If you're dreaming of countryside living, this loan could make that dream a reality.

5. Portfolio Loans for Unique Needs

Portfolio loans are kept by lenders on their books rather than being sold on the secondary market to Fannie Mae and Freddie Mac. Since the lenders keep these loans, they can customize the lending options. Portfolio lenders establish their own borrowing guidelines and terms, which can be attractive to certain borrowers. For instance, individuals seeking a jumbo loan or purchasing an investment property may encounter greater flexibility when working with a portfolio lender.

Pros and Cons

Portfolio loans are advantageous for borrowers with unique needs, such as self-employed individuals or those with non-traditional income sources. However, because they are riskier for lenders, they often come with higher interest rates.

Who It Suits

If you have a unique financial situation that doesn't fit standard loan criteria, a portfolio loan could be a viable option. It's particularly suited for investors or those with irregular income streams.

6. Seller Financing 

Seller financing allows the buyer to purchase directly from the seller rather than through a traditional mortgage lender. Rather than seeking a traditional bank mortgage, the buyer enters into a mortgage agreement directly with the seller. The popularity of seller financing fluctuates with the tightness of the credit market. When banks are risk-averse and hesitant to lend to anyone but the most creditworthy borrowers, seller financing enables more people to purchase homes and can facilitate quicker sales. Conversely, in times of loose credit markets, when banks are eager to lend, the appeal of seller financing diminishes. 

Definition

In this setup, the seller acts as the lender, and the buyer makes payments directly to them, according to mutually agreed terms. Just like in a bank financed loan, there are necessary legal documents that a settlement attorney can draft. Essential documents in seller financing include a promissory note and a mortgage or deed of trust. These documents should outline all terms of the deal, including the repayment schedule, interest rate, and consequences of default

Pros and Cons

Seller financing can be advantageous in competitive markets, offering flexible terms and potentially faster closing times. However, interest rates may be higher, and sellers may still require a substantial down payment. Of course, you also need a seller willing to offer financing and they will need to own their property outright. 

Who It Suits

Ideal for buyers who struggle to get a traditional mortgage due to credit issues or other financial hurdles, seller financing offers an alternative pathway to homeownership.

7. DSCR Loans for Investors

Debt Service Coverage Ratio (DSCR) loans are used by investors to finance rental properties based on the property's cash flow rather than on the borrower's qualifications like credit score and income. DSCR loans are based on the property's cash flow, rather than the borrower's income. The DSCR is a number that measures the property's current rental income compared to its debt obligations. A DSCR above 1.0 indicates positive cash flow, while a DSCR below 1.0 indicates negative cash flow. Lenders use the DSCR to determine the maximum loan amount when a borrower is applying for a new loan or refinancing an existing one. 

Pros and Cons

DSCR loans allow investors to leverage the cash flow of their properties, often with fewer personal financial requirements. However, the success of obtaining such a loan heavily depends on the property's expected income. DSCR loans don't require proof of income, tax returns, or a debt-to-income (DTI) ratio, which can result in faster closing times and more flexible funding solutions.

How to Calculate DSCR

The DSCR is calculated by taking net operating income and dividing it by total debt service which includes both the principal and interest payments on a loan.

Who It Suits

If you're a real estate investor looking to expand your portfolio, DSCR loans are tailored to your needs, focusing on the property's performance rather than personal finances.

8. Jumbo Loans

A jumbo loan is a type of mortgage that exceeds the conforming loan limits set by the Federal Housing Finance Agency (FHFA). These limits can vary by region, but jumbo loans typically cater to higher-value properties that fall outside of conventional loan guidelines. Because they are not backed by Fannie Mae or Freddie Mac, jumbo loans often come with stricter credit requirements, higher down payments, and potentially higher interest rates. They are ideal for affluent buyers seeking to purchase luxury homes or properties in high-cost areas, allowing them to secure financing that aligns with their specific investment goals.

Pros and Cons

Jumbo loans allow buyers to purchase high-value properties without being constrained by conventional loan limits. However, they often come with stricter requirements and higher costs due to their non-conforming nature.

9. Renovation & Rehab Loans

 Renovation and rehab loans are specialized financing options designed to help borrowers fund the purchase and improvement of a property. These loans allow buyers to incorporate the cost of renovations into their mortgage, making it easier to finance both the acquisition and the remodel in one loan package. Common types of renovation loans include the FHA 203(k) loan and Fannie Mae’s HomeStyle Renovation loan.

These loans typically cover a variety of improvements, from minor updates to major structural repairs, and can provide a streamlined way for homeowners to invest in their properties without needing separate financing for renovations. By enabling buyers to purchase fixer-uppers or older homes in need of updates, renovation and rehab loans can offer a pathway to homeownership while adding value to the property over time. 

Pros and Cons

One of the primary advantages of a rehab loan is the ability to finance both the purchase and renovation of a property in one convenient loan, simplifying the often complicated process of securing two separate loans. This can save homeowners time and money while allowing them to invest in properties that have potential but require upgrades. Additionally, rehab loans enable homeowners to undertake various renovations—from minor cosmetic changes to major structural improvements—thereby increasing the home's overall value. This flexibility provides the opportunity to tailor projects according to personal tastes or essential repairs while also gaining access to properties that might otherwise be overlooked due to their current condition.

However, there are some drawbacks to be aware of when considering rehab loans. Often, these loans come with higher interest rates than traditional mortgage options, which can lead to increased monthly payments and overall borrowing costs. Stricter approval requirements may also be imposed by lenders, necessitating detailed renovation plans and cost estimates, which can complicate the approval process. Moreover, renovation projects frequently exceed initial budget estimates, potentially leading to financial strain if additional funds are required. Finally, the need to coordinate renovations and secure necessary permits can be time-consuming, causing delays in moving into a new property and hindering the overall buying experience.

10. Non QM Loans

Non-QM (Non-Qualified Mortgage) loans are a category of mortgage products that do not meet the standard criteria set forth by the Consumer Financial Protection Bureau for qualified mortgages. Unlike traditional loans, which require strict verification of income, employment, and debt-to-income ratios, non-QM loans cater to borrowers who may not fit the conventional mold. This includes self-employed individuals, those with irregular income, or borrowers seeking to finance investment properties. Non-QM loans often come with innovative features, such as interest-only payment plans, and allow for greater flexibility in qualifying criteria. However, while they can provide accessibility to financing, borrowers should be aware that these loans may also carry higher interest rates and varying terms, leading to a more complex borrowing experience..

Conclusion

Choosing the right mortgage loan is crucial in your home buying journey. By understanding the differences between each loan type, you can make informed decisions that align with your financial situation and goals. Whether you're a first-time buyer, a veteran, or a rural resident, there's a mortgage option for you.