What are the most common types of mortgage loans?

Key takeaways

• Borrowers can choose from several loan types, including conventional, FHA, VA and USDA mortgages, each with different requirements and cost structures.
• Fixed-rate loans offer stable payments, while adjustable-rate mortgages may start with lower rates but carry the risk of future increases tied to market benchmarks.
• Lenders evaluate credit, income and debt levels, and borrowers must also account for mortgage insurance, closing costs and loan limits when comparing options.
  

Mortgage borrowers can choose from several types of loans, including conventional products and government-backed programs such as FHA, VA and USDA mortgages. Each option carries different requirements, costs and eligibility criteria.

Most home loans are conventional, meaning they are not insured by the federal government. Roughly 80% of mortgages fall into this category. Borrowers typically need a credit score of at least 620 and a down payment ranging from about 3% to 20%.

If the down payment is less than 20%, lenders generally require private mortgage insurance, or PMI, which can be removed once sufficient equity is built.

With a fixed-rate mortgage, the interest rate stays the same throughout the life of the loan. This is the most popular type of mortgage among American homeowners because the mortgage payments remain the same every month. A fixed-rate mortgage will enable you to incorporate your monthly payment into your budget because it doesn’t change.

One drawback is that rates may be higher than introductory rates on adjustable loans. If market rates fall, borrowers typically must refinance to secure a lower rate.

An adjustable-rate mortgage, or ARM, is one where the interest rate on the loan changes when it goes through an adjustment period. This type of loan is most popular with house flippers and investors, but it is also a good option for buyers who don’t intend to live in the home more than a couple of years. Over the course of an adjustable-rate mortgage, the loan will have an initial rate and period followed by an adjustable rate and period. Here’s an example:

If a lender offers a borrower a 5/1 SOFR ARM (based on the Secured Overnight Financing Rate, which replaced LIBOR as a common benchmark for adjustable-rate mortgages) at 3.25% with 2/2/5 caps, the rate on the loan will remain at 3.25% for the first five years. After that, the rate can adjust once a year based on changes in the benchmark.

The 2/2/5 caps limit how much the rate can increase:

• Up to 2 percentage points at the first adjustment

• Up to 2 percentage points at each subsequent adjustment

• Up to 5 percentage points over the life of the loan, capping the rate at 8.25%

Government-backed mortgages are insured or guaranteed by federal agencies, allowing lenders to offer more flexible qualification standards. However, borrowers may incur a higher interest rate, and depending on the type of loan, other requirements.

VA loans are available to eligible service members, veterans and certain military families. These loans typically require no down payment and do not include private mortgage insurance. Additional benefits of VA loans include:

• No prepayment penalties
• The seller can pay all the buyer’s loan-related closing costs and up to 4% in concessions
• Lower interest rates than conventional and FHA loans (3.625% VA 30-year fixed vs. 3.85% conventional 30-year fixed)
• VA mortgages are assumable
• Foreclosure avoidance advocacy

Borrowers must meet eligibility requirements set by the Department of Veterans Affairs as well as lender underwriting standards, including credit and income criteria. The VA’s eligibility requirements include:

• Borrower must be active duty or a veteran who has an available Certificate of Eligibility, or COE
• Loan must be used for an eligible purpose
• Borrower must have satisfactory credit (usually 620 or above)
• Debt-to-income ratio of 41% or lower
• Borrower must intend on living in the home for a reasonable period after closing
• The income of the veteran (and spouse, if applicable) must be sufficient and stable to meet the mortgage payments, as well as the cost of living and debt obligations

FHA loans, insured by the Federal Housing Administration, are commonly used by first-time buyers and borrowers with lower credit scores. Down payments can be as low as 3.5%.

These loans require mortgage insurance premiums. For borrowers who put down less than 10%, insurance typically lasts for the life of the loan; with higher down payments, it may be removed after a set period. Those limits vary depending on where you live, so be sure to research FHA loan requirements in your area.

USDA loans are like VA loans in that they are zero-down loans, but they are designed for those buying an eligible rural or suburban home. USDA loans are issued through the United States Department of Agriculture loan program, also known as the USDA Rural Development Guaranteed Housing Loan Program. Even though USDA loans are like VA loans, USDA loans require you to pay mortgage insurance if you don’t put any money down. There are three types of USDA loans:

• Guaranteed loans: This type of USDA loan is guaranteed by the USDA but not issued by it. A guaranteed loan needs to be obtained through a lender who participates in the program.
• Direct loans: This loan is issued by the USDA. It is usually reserved for low- and very low-income applicants. With subsidies, interest rates for USDA loans can be as low as 1%.
• Home improvement loans and grants: Home improvement loans and grants are great for homeowners wanting to repair or upgrade their homes. The USDA program also offers packages to combine a loan and a grant, providing up to $27,500 in assistance.

Jumbo loans exceed conforming loan limits, which are set annually by the Federal Housing Finance Agency and vary by region. Because they are not eligible for purchase by Fannie Mae or Freddie Mac, lenders generally impose stricter requirements, including higher credit scores and lower debt-to-income ratios.

Fannie Mae and Freddie Mac are government-sponsored enterprises that help provide liquidity to the mortgage market.

Today, both are shareholder-owned companies operating under congressional charters. They purchase mortgages from lenders and either hold them or package them into mortgage-backed securities that can be sold to investors. This process allows lenders to replenish funds and continue issuing new loans, supporting the availability of mortgage credit.

Conforming loans meet standards set by the Federal Housing Finance Agency and can be purchased by Fannie Mae or Freddie Mac. Nonconforming loans do not meet those criteria and include jumbo loans and government-backed mortgages such as FHA, USDA and VA loans. Conforming loans often carry lower interest rates and more standardized underwriting, while nonconforming loans are typically used for borrowers whose needs fall outside those limits, such as higher-priced properties or specialized financing programs.

The 2008 housing crash highlighted how certain loan structures can increase risk for borrowers. While many of those products are less common today, some features can still add cost or complexity.

• Balloon loans: These loans require a large lump-sum payment at the end of a relatively short term. Borrowers may face refinancing risk or payment shock when the balance comes due.
• Lease-purchase agreements: Also known as rent-to-own arrangements, these agreements allow a renter to apply a portion of monthly payments toward a future purchase. Terms vary, and some payments or fees may be nonrefundable if the purchase is not completed.
• Prepayment penalties: Some loans include fees for paying off the mortgage early through refinancing or a home sale. These penalties vary by lender and loan terms, though many standard mortgages do not include them.

This story was updated on May 13.