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What Kinds of Mortgage Loans Are Available?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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When it comes to financing the largest purchase you’ll ever make in your life — your home — it’s essential that you approach it as an informed consumer. Not educating yourself during the mortgage process could mean ending up with a more expensive loan than necessary and could cost you tens of thousands of dollars.

To avoid that, make sure you have an understanding of all your financing options. In this guide, we’ll go over the different types of mortgage loans to help you find the one that best meets your needs.

Mortgages are classified based on a few overarching criteria.

  • Government-backed or conventional. All mortgages fall into one of the two categories.
  • Fixed-rate or adjustable rate. This refers to how the interest rate on the mortgage is structured.
  • Jumbo or conforming. The amount of the loan dictates whether it is a conforming or jumbo loan.

Tendayi Kapfidze, chief economist for LendingTree, the parent company of MagnifyMoney, said multiple factors dictate which loan product is best for an individual. You’ll need to consider the size of your down payment, the price of the home, your credit history, your risk tolerance and your eligibility for specific loan programs. “Once you have some preferences on those, then you shop around and see what kind of deals you’re getting,” Kapfidze said.

Let’s take a look at the various loan options.

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Government-backed vs. conventional home loans

Loans are defined one way by whether they’re a government loan or not. The government offers three loan programs: FHA, VA and USDA. A conventional mortgage is any loan that is not a part of one of these programs.

Government-backed loans target and serve consumers who may be underserved by traditional financing. Because lenders potentially take on greater risk by extending credit to these borrowers, the government provides protection to lending institutions by insuring the loans. The cost of insuring or guaranteeing the loan is passed on to the buyer through fees built into the mortgage.

Federal loans tend to be more expensive than conventional loans, but they are easier to qualify for. You may need a lower credit score to qualify, and you may be able to put down a smaller down payment.

Let’s review the three types of government loans.

FHA

FHA loans are insured by the Federal Housing Administration. These loans let you purchase a home with a down payment as low as 3.5% and a credit score as low as 500, depending on the size of the down payment.

You’ll be limited in the amount you can borrow, based on the market rate for homes in a specific area. With FHA financing, homebuyers usually pay mortgage insurance premiums through an upfront charge of 1.75 of the loan amount, which can be rolled into the mortgage. Additionally, you’ll pay an annual mortgage insurance premium that is built into the monthly payment.

You can finance properties of between one and four units as well as mobile and manufactured homes that meet FHA program requirements. You apply for FHA loans through FHA-approved private lenders.

Advantages of an FHA loan:

  • Low down payment
  • Lenient credit requirements
  • Low closing costs

FHA loans are best for:

  • First-time homebuyers who don’t have home equity already built up that could go toward a down payment
  • Buyers with lower credit scores
  • Buyers with low down payments

VA

The Department of Veterans Affairs backs mortgages for veterans, service members and eligible surviving spouses. Borrowers can purchase homes with no money down and lenient credit requirements.

There is no purchase price limit with a VA loan. However, there are limits on how much you can finance without putting money down.

Applicants will need to meet the VA’s residual income guidelines, which establish how much income you must have left over after covering all debts and living expenses.

VA loans do not require the borrower to pay mortgage insurance, but you will pay an upfront funding fee, which is a percentage of the loan amount. You can apply for VA loans through approved private lenders.

Advantages of a VA loan:

  • No down payment (unless a lender requires one)
  • No minimum credit score (unless a lender requires one)
  • No mortgage insurance required
  • No maximum loan amount
  • No maximum debt-to-income ratio (DTI) (unless set by the lender)

VA loans are best for:

  • Veterans, service members and eligible surviving spouses
  • First-time homebuyers
  • Buyers with low or no credit score
  • Buyers with little or no down payment

USDA

Buyers in rural areas can seek financing through the United States Department of Agriculture.These programs are income-sensitive, and you must purchase a property in an eligible rural area.

The USDA has two loan programs:

Guaranteed loan program. In this program, loans are offered by local lenders and guaranteed by the USDA. Your income must fall within the income limits established for low- or moderate-income households, determined by the location of the home and your family size.

These loans carry an upfront loan guarantee fee and may also include an annual fee, both of which are at the borrower’s expense. The lenders set the interest rate for these loans, but rates are capped by the USDA.

Direct loan program. In this program, you can finance a home directly with the USDA. Your income must fall within the established guidelines for very low or low-income households. And the property itself must meet specific criteria. For example, homes must be 2,000 square feet or less in most cases.

Additionally, this program limits the purchase price based on location. Interest rates are lower in the direct loan program than the guaranteed loan program, and there is no mortgage insurance or guarantee fee. Some applicants may qualify for a payment subsidy, which can lower the effective interest rate to as low as 1%.
Advantages of a USDA loan:

  • No down payment required
  • Flexible credit requirements
  • Closing costs can be financed
  • Longer loan terms can reduce the monthly payment

USDA loans are best for:

  • First-time homebuyers
  • Low-income borrowers
  • Rural residents
  • Buyers with low or no credit score
  • Buyers with little or no down payment

Conventional

As mentioned previously, any loan that is not a part of a government program is a conventional loan. These loans are issued by private lenders and are not backed or insured by the federal government.

Conventional loans require higher down payments than government-backed loans — typically, a minimum of 5% — although some lenders offer programs with down payments as low as 3%. Borrowers who put down less than 20% will need to pay for private mortgage insurance, or PMI, which is added to the loan payment.

Credit requirements are a bit tighter with conventional financing and vary by lender. Borrowers with higher scores will qualify for better rates.

Advantages of a conventional loan:

  • Lower fees than government loans

Conventional loans are best for:

  • Applicants with good to excellent credit
  • Applicants putting down 5% or more

Fixed-rate vs. adjustable-rate mortgages (ARMs)

Mortgages are also classified by the structure of their interest rate. Loans have either a fixed rate or an adjustable rate.

Fixed-rate mortgages

The interest rate and monthly payment on a fixed-rate mortgage remain the same throughout the life of the loan. That means your payments are predictable, and you’re protected from interest rate hikes. Conversely, it also means you cannot take advantage of any interest rate drops unless you refinance the loan.

Advantages of a fixed-rate mortgage:

  • Stability
  • Easier to plan for
  • Protects you from rate increases

Disadvantages of a fixed-rate mortgage:

  • Cannot take advantage of interest rate decreases
  • Higher rates than adjustable-rate mortgages

Fixed-rate mortgages are best for:

  • Most buyers
  • Borrowers who are risk-averse
  • Borrowers who cannot afford an increase in their payment

ARMs

Unlike fixed-rate loans, the interest rate on adjustable-rate mortgages adjusts throughout the loan. The rate is tied to an index that the lender uses. As the index goes up or down, the mortgage rate and the monthly payment increase or decrease.

Interest rates on ARMs are usually lower than fixed-rate loans initially, but as the market fluctuates, the rate could increase significantly.

Adjustable-rate mortgages can differ in how they are structured. But generally, these loans have a period when the rate is fixed, which can range from one month to 10 years. The most common fixed terms are three, five, seven and 10 years.

Once the fixed period ends, the interest rate will adjust at predetermined intervals — monthly, quarterly, annually or every three or five years. The most common adjustment period is one year, which means the interest rate and payment will change once per year until the end of the loan.

When comparing ARMs, you’ll notice that they are written with two numbers such as 3/1, 5/1 or 10/1. The first number represents the fixed period while the second number represents how often the rate will adjust.

For example, a 3/1 ARM will have a fixed rate for three years and will adjust annually after the fixed period ends. A 5/1, 7/1 and 10/1 ARM will have fixed periods of five, seven and 10 years respectively, followed by annual adjustments.

The initial low rates of ARMs can be appealing for some buyers, but those rates will likely increase. “If you do consider an ARM, make sure you’re very comfortable with the possibility of your payment going up,” Kapfidze advised.

Advantages of an ARM:

  • Lower rates initially
  • Interest rates and payment could decrease

Disadvantages of an ARM:

  • Very risky and unpredictable
  • Interest rate and payment can increase significantly

Conforming vs. jumbo loans

Conventional loans are defined by another classification: conforming or jumbo.

Conforming mortgage loan

Conventional loans have maximum price limits in place set by the government as well as other guidelines established by Fannie Mae and Freddie Mac, the government-sponsored companies that insure a majority of conventional loans.

Limits are based on geographical area, with higher loan amounts allowed in counties that are considered “high cost.” Conforming loans are those that fall within the loan limits. In most of the United States, the limit for one-unit properties is $484,350 in 2019.

Jumbo mortgage loan

Borrowers who want to purchase above the conforming loan limits will need to take out a jumbo loan.

Qualification requirements are usually stricter for jumbo loans, with borrowers needing higher down payments and a strong credit profile.

Determining the right mortgage for you

Now that you have a better understanding of the types of loans, you can compare various options to see what is best for you. Again, give thought to the size of your down payment, the price of the home you wish to buy, your credit history and your risk tolerance.

Additionally, Kapfidze said one of the most important factors to consider is your bottom line. Before shopping for a loan, he advises that consumers should ask themselves how much they are able and willing to pay for a mortgage. The best way to answer that is to come up with a monthly budget projecting the prospective mortgage payment and expenses related to the home, including taxes, insurance, maintenance, repairs and utilities.

“Get a complete all-in monthly housing cost that you’re comfortable with,” Kapfidze said. He added that once you have that number, you can review the loan options that line up with your budget.

Doing this before you begin shopping is crucial, as it’s easy to get swept up in the emotion of buying a home. He also said consumers should talk to several lenders. “There’s always a lender out there that will work with your situation, you just have to find them,” he said. “The more lenders you talk to, the more chances you’ll have of finding that lender that fits your particular circumstances.”

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.

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Mortgage

Getting Preapproved for a Mortgage: A Crucial First Step

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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Getting a mortgage preapproval is a crucial stepping stone on your way to becoming a homeowner, but it doesn’t mean you’re in the clear to borrow from a lender just yet. A preapproval does give you a leg up over the competition, though.

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What is a mortgage preapproval?

A mortgage preapproval means a lender has vetted your credit and finances and has made an initial loan offer based on its findings. Lenders share this information in writing, so you may hear it referred to as a preapproval letter.

Getting prequalified for a home loan is not the same as a preapproval. Mortgage prequalification provides a rough estimate of how much you might qualify for, based on a surface-level review of your financial information.

A preapproval, however, is a more thorough vetting of your finances and provides a more accurate idea of what a lender may offer in terms of a loan amount and interest rate. You provide financial documentation and agree to a review of your credit profile, which means the lender will pull your credit reports and scores. With a prequalification, you typically self-report your financial information and lenders don’t check your credit.

5 steps to getting preapproved for a mortgage

It’s not worth falling in love with a house until you know the sales price matches up with a mortgage amount you can realistically afford. Here’s how to get preapproved for a mortgage.

  1. Determine your homebuying timeline. The best time to apply for a mortgage preapproval is before you start house hunting. You may want to hold off on a preapproval if you’re not quite ready to begin the homebuying process. Even if you’re not yet prepared, you can get started by pulling your free credit reports from each bureau at AnnualCreditReport.com and reviewing minimum mortgage requirements.
  2. Review and improve your credit profile. With your credit reports in hand, it’s time to look for areas of improvement. The minimum credit score you need for a mortgage varies by program type, but you’ll need at least a 620 credit score in many cases. Dispute any inaccurate information you find, keep your credit card balances low and consistently pay your bills on time. Refrain from applying for new credit and closing any of your existing accounts, too.
  3. Pay down your debt. Pay down your debt. Aside from your credit scores, lenders care about how you manage your debt now and how you’ll fare if you get a mortgage. Your debt-to-income ratio, or the percentage of your gross monthly income used to repay debt, should stay at or below 43%. The less debt you have, the less risky you appear to lenders.
  4. Gather your documents. Lenders will request several documents from you for a preapproval, including:
    • Government-issued photo ID
    • Social Security number
    • Bank statements from the last 60 days
    • Pay stubs from the last 30 days
    • Two years of W-2s or 1099 tax forms
    • Credit reports and scores from all three bureaus
  5. Apply with multiple lenders. Consider banks, credit unions, mortgage brokers and nonbank lenders when applying for a mortgage preapproval, and shop around with three to five lenders to get the best rates. Additionally, keep your shopping period within 14 to 45 days to minimize the impact of those credit inquiries against your credit scores.

How long does a mortgage preapproval last?

A mortgage preapproval typically lasts for 30 to 60 days. The average time to close on a house is 48 days, according to Ellie Mae’s latest Origination Insight Report, so there’s a chance you can get through the full homebuying process before time runs out.

If your preapproval letter expires before you close, you’ll need to go through the process again, submit documentation and have your credit reports and scores pulled, which creates a new credit inquiry and affects your score.

Pros and cons of mortgage preapproval

The mortgage preapproval process includes several benefits, but there are also drawbacks to consider.

Pros:

  • You’ll get a better idea of how much house you could afford, which helps narrow down your price range.
  • Home sellers take you more seriously because you’ll have proof that a lender is willing to back you when you submit an offer.
  • You can comparison shop before committing to a lender.
  • Even if your preapproval is denied, you may walk away with an analysis of where you stand financially and how you can improve.

Cons:

  • A preapproval is not a full approval. It doesn’t guarantee you’ll qualify for a mortgage.
  • Preapprovals typically last for 30 to 60 days. If you don’t buy a home within this time frame, you’ll need a new mortgage preapproval letter.
  • Making changes that affect your credit, such as applying for a new credit line or racking up debt, can prevent you from getting a full mortgage approval.

What happens after you get preapproved for a mortgage?

Once you’ve been preapproved and have chosen a mortgage lender, it’s time to find your home and submit an offer to buy it. You’ll also continue working your way through the mortgage approval process, which includes:

  • Providing your lender with any additional documents needed to finalize your loan.
  • Getting a home appraisal and home inspection.
  • Preparing for your walk-through and closing day.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.

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Mortgage

Bridge Loans: What They Are and How They Work

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

If you’re shopping for a home in a hot real estate market, you might find that sellers aren’t willing to wait for you to sell your home before you buy. In that case, a bridge loan can help you purchase your next home without the pressure of selling yours first.

Before you take the plunge into the bridge lending world, learn the ins and outs with this guide to understanding bridge loans.

What is a bridge loan?

A bridge loan is a short-term mortgage you can use to access equity in a home you are selling in order to purchase a new home. Bridge loans are commonly used in tight housing markets where bidding wars demand competitive purchase offers without any contingencies.

How does a bridge loan work?

Bridge loans work in two different ways — as a first mortgage to pay off your current loan and fund the down payment of a new house, or as a second mortgage, with the money applied to the down payment of a new home. Let’s explore how each of these work.

First mortgage bridge loan: One large loan is taken out for up to 80% of your home’s value. The funds are initially used to pay off the current mortgage balance. Any extra money leftover is used toward the down payment for your new home.

Second mortgage bridge loan: This option involves borrowing the difference between your current loan balance and up to 80% of your home’s value. The mortgage on your current loan is left alone, and the second mortgage bridge funds are applied to the down payment on the home you’re buying.

Here’s an example of how each option would look if your current home is worth $350,000 with an outstanding loan balance of $200,000, assuming you borrow 80% of your current home’s value.

Bridge loan optionMaximum loan amountHow funds are applied
First mortgage bridge loan$280,000$200,000 to current loan payoff

$80,000 to down payment new home
Second mortgage bridge loan$80,000$80,000 to down payment new home

Pros and cons of buying a home with a bridge loan

Pros

Tap home equity while your home is for sale. A bridge loan lets you tap the equity you’ve built in your current home while it’s for sale to buy a new home. Standard lending guidelines for conventional loans don’t allow cash-out refinancing on a property listed for sale.

Avoid making an extra move. A bridge loan allows you to move while your current home is still being sold so you’re not stuck finding a temporary place to live if you can’t time both sales perfectly.

Pay off the balance of your current loan and get extra cash. If you have a significant amount of equity in your home, you may be able to pay off your current mortgage while you wait for your home to sell. You can then use any extra cash toward a bigger down payment on your new home. This prevents you from paying two mortgage payments until your old home is sold.

Use bridge funds as a second mortgage to buy your new home. If your current mortgage rate is low, paying the entire balance off with a bridge loan doesn’t make sense. If you borrow the equity you have you in your current home as a second mortgage, you’ll have a lower bridge loan balance and payment.

Buy a new home without waiting for your current home to sell. A bridge loan eliminates the need for a home sale contingency, making your offer more competitive in a tight housing market.

Make interest-only payments until your home sells. Some bridge loan programs offer an interest-only option, which means you pay only the interest charges accruing each month. The interest rate may be slightly higher, but it will soften the impact of having two monthly mortgage payments.

Cons

You’ll make two or three mortgage payments. Once you borrow against your equity and buy your new home, you’ll be carrying at least two, possibly three monthly mortgage payments, depending on how you use the bridge loan. This can add up fast and become unsustainable.

Higher interest rates and closing costs. Like most short-term lending options, bridge loans come with higher interest rates and closing costs. Lenders charge higher rates and fees to make it worth their while because you are borrowing only for a short time. You might have trouble making the payments on both mortgages if you have a hard time selling your current home.

Increases the risk of defaulting on two mortgages. Bridge lenders expect you will be able to pay off the loan within a year. If the balance isn’t paid by then, they can foreclose on your home. As a result, your credit and finances will take a massive hit, and you might be unable to repay the mortgages on both homes.

Need substantial equity to qualify. Bridge loans are not a viable choice if you don’t have a good chunk of equity in your home. You can borrow up to 80% of the value of your home, so if you’re in an area where neighborhood values have dropped, you’ll want to come up with alternative financing.

Not as regulated as traditional mortgages. When regulatory reform was passed, it was intended to focus on long-term loan commitments to protect borrowers from taking out loans they couldn’t repay. The new rules don’t apply to temporary or bridge loans with terms of 12 months or less, meaning you’ll have less protection.

How to qualify for a bridge loan

Bridge loans are specialty mortgage loans, and they aren’t approved based on the same standards as a regular mortgage. Lenders that offer these loans have a few extra qualifying hoops for you to jump through, and rates and fees vary depending on property type, too.

Here are some key qualifying requirements unique to bridge loans:

Enough income to cover multiple mortgage payments

Bridge lending guidelines are often set by private investors or are specialized programs offered by institutional banks. That means they can create their own guidelines. Some bridge lenders may not count your current mortgage payment against you because they approve the loan knowing your intent is to pay it off quickly.

Other lenders will require you to qualify with both loans, which could mean you can’t tap into the full amount of your equity unless you have enough income.

At least 20% equity in your current home

Bridge loans work best if you have more than 20% equity, but the bare minimum requirement is 20%. If you don’t, it’s unlikely you’ll qualify for a bridge loan.

A commitment to paying off the loan quickly

Bridge lenders will scrutinize the home you are selling more than the home you are buying to make sure it’s priced to sell within bridge loan’s term period, usually 6 to 12 months. An appraisal will be required on your current home, and if the value comes in significantly lower than what your asking price is, your loan amount will be reduced.

Average closing costs for a bridge loan

Bridge loan closing costs typically range from 1.5% to 3% of the loan amount, and rates can be as high as 8% and 10% depending on your credit profile and how much you are borrowing. Beware of any lender that asks for an upfront deposit to approve a bridge loan; they probably aren’t a legitimate lending source and you should steer clear.

How to find a bridge loan lender

Bridge lending is a niche product, so not every lender will offer the option. You’ll need to shop around with mortgage brokers and institutional banks. Also, ask your current mortgage broker or loan officer whether they have experience closing bridge loans.

Work with a legitimate, licensed loan officer. You can check licensing requirements for all 50 states with the Nationwide Multistate Licensing System Consumer Access link. Type in your loan officer’s name or company information. Here are examples of lenders who may offer bridge loans:

Institutional lenders

Start with your local bank to discuss their bridge loan programs. If you have a substantial amount of deposits with a bank, the bridge loan terms might be more flexible and approval might go more smoothly.

Alternative lenders

Mortgage brokers and mortgage bankers often have relationships with alternative lenders. They can often find a bridge loan source if your current bank doesn’t offer them.

Hard money lenders

A hard money loan may be a good fit for bridge financing to purchase fix-and-flip investment property. Hard money lenders are often private investors, or groups of private investors, looking for high returns on short-term real estate loans. Interest rates can run into the double digits, and you can expect a prepayment penalty and fees range between 2% to 10%, depending on how risky your credit profile is.

Alternatives to using a bridge loan

You can do some advance planning to avoid needing a bridge loan, or at least limit how much bridge financing you need to purchase a home. Here are some other options to consider:

Use an existing home equity line of credit (HELOC)

If you already have a HELOC on your home before you start searching for a new home, you can use the HELOC toward a down payment on your new home. Typically there are no limitations on how you can use HELOC funds. A few drawbacks: You might have to pay a close-out fee when your home sells and the HELOC is paid off and closed, and you won’t get a mortgage interest tax deduction on the extra borrowed equity. You also risk losing your home if you can’t repay the loan because your home is serving as collateral for the loan.

Take out a 401(k) loan

Your retirement savings account can be another tool to bridge the gap in financing, and the rates and payment may be significantly less than what you’ll pay for a bridge loan. Check with your plan provider for any restrictions on loans for home purchases. It may be more cost-effective to take out a 401(k) loan to avoid the closing costs and high interest rates that come with a bridge loan.

The drawback to a 401(k) loan is that the borrowed money is taken from your retirement savings and won’t be working for you in the market. Consider this option only if you plan to repay the loan immediately after your current home sells.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.