Choosing the right type of mortgage depends on your financial goals and your current circumstances. Learn about the different types of loans and their respective interest rates so you can make the most informed decision possible.
There are two basic types of mortgages: fixed-rate and adjustable-rate mortgages. Its important to understand how these differences will impact your payments and what to expect when they change.
Fixed-rate mortgages
The main difference between a fixed-rate mortgage (FRM) and an adjustable-rate mortgage is that with a FRM, interest rates are guaranteed to stay the same for the life of the loan. This stability is a major selling point for many homebuyers.
A fixed-rate mortgage generally lasts between 10 and 30 years. The longer the term, the more expensive it will be because of the amount of interest you will pay over the entire duration.
However, if you are not sure when you will move, a shorter term may make more sense as it can save you money in the long run.
The other big benefit of a fixed-rate mortgage is that you are protected from sudden increases in your payments. This is an important feature for borrowers with stable incomes, who may be concerned that their monthly payments will increase significantly if interest rates go up.
Adjustable-rate mortgages
Adjustable-rate mortgages, or ARMs, offer lower interest rates for a shorter period than fixed-rate mortgages. But these loans come with risk because they can fluctuate in the future.
Typically, ARMs have an initial fixed rate for a few years and then adjust semi-annually based on a corresponding financial index. These indexes are based on market conditions, not your personal financial situation.
There are many indexes, and your loan paperwork identifies which one your adjustable-rate mortgage follows. When the initial introductory rate is over, your new interest rate will be the index plus an agreed-upon margin.
Your ARM may also include a cap on how much the interest rate can increase during each adjustment period (cap) or over the life of the loan (lifetime cap). And there are safeguards to protect borrowers from higher monthly payments.
ARMs are becoming more popular again, especially among borrowers seeking to buy homes with low mortgage rates. But if you are considering an adjustable-rate mortgage, you must consider the long-term implications and whether it is a good choice for you.
Conventional mortgages
The conventional mortgage is the most popular type of home loan. It is typically repaid over 30 years, but can also be a 15- or 20-year loan. Interest rates for a conventional mortgage vary based on your credit score, the amount of your down payment and your loan term.
Conventional loans meet specific standards set by Fannie Mae and Freddie Mac, which are government-sponsored companies that back trillions of dollars in mortgages. The federal Housing Finance Agency oversees these companies and sets the standards that they must follow to keep the mortgage market safe.
Conforming conventional loans must fall within loan limits that change each year. In 2022, the conforming limit for a single-family home was $726,200 ($970,800 in high-cost areas).
To qualify for a conventional loan, youll need to have a credit score of 620 or higher. If your credit is lower, you may need to pay private mortgage insurance (PMI) to protect your lender from loss if you default on the loan.
Jumbo mortgages
If you’re looking to finance a home that exceeds Fannie Mae and Freddie Mac loan limits, a jumbo mortgage may be the only option. This type of loan requires higher credit requirements, a bigger down payment and more stringent financial documentation than conforming loans.
Jumbo mortgage rates can be more competitive than other types of mortgages, but it’s important to shop around and compare offers from different lenders. Larger national and regional lenders are generally more likely to offer jumbo loans, although some local banks and credit unions also may have good rates.
When shopping for a jumbo loan, keep in mind that your interest rate will be based on your credit score and debt-to-income ratio. Those numbers help your lender determine if you have the financial means to make your monthly payments. Lenders will also look at how much money you have in cash reserves to cover six-12 months of mortgage payments plus closing costs.