Dive into the world of mortgages and discover the most common options available, whether you’re stepping onto the property ladder for the first time, undertaking a major renovation, consolidating debt, or simply looking to refinance your existing home loan.
Your Mortgage Options Explained
A diverse array of mortgage solutions exists, including conventional, fixed-rate, and adjustable-rate mortgages, alongside government-backed and jumbo loans. The optimal loan for your individual needs will hinge on your specific objectives. Common scenarios where different options shine include: buying your first home, constructing a new property, renovating an existing one, consolidating debts, purchasing another home, or refinancing to secure a lower interest rate.
Conventional Mortgages
Conventional mortgages represent the most frequently encountered type of home loan. That said, they often carry distinct requirements for a borrower’s minimum credit score and debt-to-income (DTI) ratio when compared to other loan avenues.
Generally, you can qualify for a conventional mortgage with a minimum credit score of 620 and a DTI of up to 50%.
For first-time homebuyers or those whose qualifying income is classified as low income by the U.S. Department of Housing and Urban Development (HUD), a conventional mortgage can be secured with a down payment as low as 3%. If your income does not meet the low-income threshold, a minimum down payment of 5% is typically required, along with a minimum credit score of at least 620.
You can bypass the need for Private Mortgage Insurance (PMI) if your down payment is at least 20%. However, a down payment below 20% will necessitate PMI payments. PMI serves to protect the lender in the event that you cease making loan payments. Notably, PMI rates for conventional loans are usually lower than those for other loan types, such as FHA loans.
Conventional loans are an excellent choice for most borrowers who aim to leverage lower interest rates in conjunction with a larger down payment.
Advantages of Conventional Mortgages:
- The overall borrowing cost, including fees and interest, tends to be lower than many other loan types.
- Down payments can be as modest as 3%–5% for qualifying loans.
Disadvantages of Conventional Mortgages:
- PMI is mandatory if the down payment is less than 20%.
- You must satisfy stricter qualification criteria, which may include a higher minimum credit score of 620 and a lower DTI.
Beneficial for:
- Borrowers who can provide at least a 3%–5% down payment and possess a minimum FICO® Score of 620.
- Borrowers with a DTI of 50% or less.
Fixed-Rate Mortgages
A fixed-rate mortgage is characterized by a consistent interest rate and unchanging principal/interest payment throughout the entire loan term. While your overall monthly payment might fluctuate due to changes in property tax and insurance rates, fixed-rate mortgages primarily offer remarkable predictability in your monthly housing expense.
A fixed-rate mortgage could be an ideal choice if you envision yourself living in your “forever home.” A stable interest rate provides a clearer financial picture of your monthly mortgage commitment, significantly aiding in long-term budgeting and planning.
Advantages of Fixed-Rate Mortgages:
- Monthly principal and interest payments remain constant for the entire duration of your loan, facilitating easier financial planning and budgeting.
- Your loan is fully amortized over its term, meaning your payment will not change throughout the mortgage.
Disadvantages of Fixed-Rate Mortgages:
- You will typically pay a higher initial interest rate compared to the introductory rate offered on an adjustable-rate mortgage.
- If initial interest rates are high, you may end up paying more in total interest over the loan’s lifetime.
Beneficial for:
- Buyers who prefer not to worry about fluctuating monthly principal and interest payments in the future.
- Buyers who are purchasing or refinancing their long-term residence and do not anticipate moving anytime soon.
Adjustable-Rate Mortgages (ARMs)
Adjustable-rate mortgages (ARMs) feature an initial fixed interest rate period, typically spanning 3, 5, 7, or 10 years. For instance, a 5/1 ARM loan maintains a fixed rate for the first five years. After this initial period, your interest rate will adjust based on a predetermined index.
The index is a benchmark interest rate that reflects general market conditions, while the margin is a fixed number set by your lender during your loan application. When your initial fixed rate expires, your new interest rate is calculated by adding the index and the margin. If the index rates increase, your rate will go up. Conversely, if they fall, your rate will decrease.
ARMs incorporate rate caps that dictate the maximum amount your interest rate can change within a given period and over the lifetime of your loan. These caps serve to protect you from excessively rapid increases in interest rates. For example, even if market interest rates continue to climb year after year, your loan rate will not exceed its predefined cap. These rate caps also work in the opposite direction, limiting how much your interest rate can decrease.
Advantages of Adjustable-Rate Mortgages:
- They often provide lower interest rates during the initial introductory period.
- The initial lower monthly payments can offer greater budget flexibility.
Disadvantages of Adjustable-Rate Mortgages:
- If the rate increases after the fixed-rate period, your monthly payments can rise.
- Fluctuating interest rates and mortgage payments make it more challenging to predict your long-term financial standing.
Beneficial for:
- Individuals seeking a lower introductory rate when purchasing a starter home.
- Those who do not expect to reside in their home for the entire duration of the loan term.
Government-Backed Loans
Government-backed loans are insured by government agencies, such as the Federal Housing Administration (FHA), Veterans Affairs (VA), or the United States Department of Agriculture (USDA). When lenders refer to government-backed loans, they are typically speaking of these three types: FHA, VA, and USDA loans.
Government-backed loans can offer broader qualification opportunities. While each type has specific eligibility criteria and unique benefits, you might find savings on interest or down payment requirements, depending on whether you meet the necessary qualifications.
FHA Loans
FHA loans are insured by the Federal Housing Administration. An FHA loan can enable you to purchase a home with a credit score as low as 580 and a down payment of 3.5%. With an FHA loan, it’s even possible to buy a home with a credit score as low as 500 if you provide at least a 10% down payment.
USDA Loans
USDA loans are insured by the United States Department of Agriculture. USDA loans typically feature lower mortgage insurance requirements than FHA loans and can even allow you to buy a home with no money down. To qualify for a USDA loan, you must meet specific income requirements and purchase a home within an eligible suburban or rural area.
VA Loans
VA loans are insured by the Department of Veterans Affairs. A VA loan provides a path to homeownership with little to no down payment and often comes with a lower interest rate compared to most other loan types. To qualify for a VA loan, you must meet service requirements within the Armed Forces or National Guard.
Advantages of Government-Backed Loans:
- Potential for savings on interest and down payments, which can translate to reduced closing costs.
- These loans may offer broader qualification opportunities for a wider range of borrowers.
Disadvantages of Government-Backed Loans:
- You must fulfill specific criteria to qualify.
- Many types of government-backed loans have mandatory upfront insurance premiums (also called funding fees), which can result in higher overall borrowing costs.
Beneficial for:
- Individuals with limited cash savings for a down payment.
- Those with lower credit scores.
Jumbo Loans
A loan is classified as jumbo if its amount exceeds the loan-servicing limits set by Fannie Mae and Freddie Mac—currently £806,500 for a single-family home across all states (except Hawaii and Alaska and a few federally designated high-cost markets in the US context). [Note: While the exact thresholds and names like Fannie Mae/Freddie Mac are US-specific, the concept of a “jumbo” or “large value” mortgage exists in the UK where it exceeds standard lending criteria.]
Freddie Mac and Fannie Mae are acronyms for congressionally established home mortgage companies in the US. The Federal Home Loan Mortgage Corp. became Freddie Mac, and the Federal National Mortgage Association became Fannie Mae.
Advantages of Jumbo Loans:
- Their interest rates are often comparable to those of conforming loans.
- They allow for borrowing larger sums for more expensive homes.
Disadvantages of Jumbo Loans:
- Qualification for a jumbo loan typically demands a credit score of 700 or higher, larger funds for a down payment and/or cash reserves, and a lower DTI ratio than other loan options.
- You’ll generally need a substantial down payment, usually between 10%–20%.
Beneficial for:
- Those requiring a loan exceeding £806,500 (or the equivalent high-value threshold in the UK) for a high-end property, and who possess a strong credit score and low DTI.
Other Mortgage Options
Beyond the commonly discussed mortgage types, several alternative home loan options offer less traditional routes to homeownership. These can be particularly relevant if you need to borrow beyond standard loan limits or wish to alter how your mortgage interest is structured.
Balloon Loans
A balloon loan is a mortgage structured with a lump-sum payment schedule. This means that at a specific point during the loan’s term, usually at the very end, you will be required to pay off the remaining balance in one large installment.
Depending on your lender, you might pay only interest for the majority of the loan term and then make one significant principal payment at the end, or a combination of interest and principal with a somewhat smaller lump-sum payment at the close.
Balloon loans offer the advantage of low monthly payments, giving you the flexibility to use your money for other purposes, such as building credit or savings, before facing your eventual lump-sum payment.
These loans can be a strategic choice for homeowners who anticipate moving relatively quickly or for those who can comfortably pay off the lump sum amount rapidly, thereby avoiding long-term mortgage payments.
Interest-Only Loans
An interest-only mortgage shares a similarity with some balloon loans in that it may permit a borrower to pay only the interest on the loan for their monthly payment, rather than both interest and principal. However, unlike a balloon loan, interest-only mortgages typically only allow for interest-only payments for a predetermined number of years. After this period, your monthly payment will begin to include principal repayment, which will lead to a substantial increase in your monthly outlay.
Most interest-only loans are ARMs, meaning the interest rate on the loan will adjust periodically based on prevailing market rates, causing your monthly payments to fluctuate up or down. These loans are often structured as “5/6” for example, where the “5” denotes the number of years you pay only interest, and the “6” indicates that your rate will adjust every six months thereafter.
While interest-only fixed-rate mortgages do exist, they are exceedingly rare. ARMs can prove more expensive over the long term, so if a guaranteed non-increasing rate appeals more to you, refinancing to a conventional fixed-rate loan might be a better option.
Construction Loans
A construction loan is a short-term financing option designed to cover the costs of building or rehabilitating a home. It differs from a traditional mortgage where you make regular monthly payments of principal and interest.
Construction loans are structured like lines of credit: you draw funds from the loan as needed to pay contractors for their work, and you typically make only interest-only payments during the construction phase. Once your home is complete, you will pay off this temporary construction loan by securing a long-term mortgage loan, most commonly a conventional mortgage.
Home Equity Term Loans
A home equity loan—also known as an equity loan, home equity installment loan, or second mortgage—is a type of consumer debt. Home equity loans allow homeowners to borrow against the equity they have built up in their homes.
The loan amount is determined by the difference between the home’s current market value and the homeowner’s outstanding mortgage balance. Home equity loans tend to be fixed-rate, whereas their common alternative, home equity lines of credit (HELOCs), generally feature variable rates.
Home Equity Lines of Credit (HELOC)
A home equity line of credit (HELOC) is a revolving line of credit secured by your home. It provides you with flexible access to funds for large expenses or for consolidating higher-interest rate debts from other loans, such as credit cards.
A HELOC often carries a lower interest rate than some other common loan types, and the interest may even be tax-deductible (check local tax regulations for applicability, e.g., in the UK, interest on loans not used for property improvement is generally not deductible). With a HELOC, you are borrowing against the available equity in your home, and the house serves as collateral for the line of credit. As you repay your outstanding balance, the amount of available credit is replenished, much like a credit card.
This means you can draw on the credit line repeatedly if needed, and you can borrow as little or as much as you require throughout your draw period (typically 10 years), up to the credit limit established at closing. At the conclusion of the draw period, the repayment period (typically 20 years) commences.
NBC Signature Gold Mortgage (Specific Product Example)
National Bank of Commerce’s Signature Gold Mortgage is an exclusive offering for customers with a combined household adjustable gross income exceeding £240,000, or verified investable assets over £500,000, or a net worth greater than £1,000,000.
This loan is intended for single-family primary residences and second homes and can be used for both purchases and refinances. A minimum credit score of 700 is required. Up to 100% of the purchase price or appraised value (whichever is less) is available for loan amounts up to and including £1,000,000. For loan amounts over £1,000,000 and up to and including £1,500,000, up to 95% of the purchase price or appraised value (whichever is less) is available.
Private Mortgage Insurance (PMI) is not required for this specific product. An active NBC checking account with a qualified direct deposit is also a prerequisite for qualification.