Types of Home Loans
There are three main loan options available for first-time homebuyers. There are important differences between the products and their eligibility. Be sure to assess your situation carefully to find the right product for you.
This is the most popular mortgage product around. The conventional loan is typically the least expensive option, but with many exceptions to this rule. The affordability comes from typically lower interest rates.
However, conventional loans are more difficult to qualify for and usually require more cash upfront. A higher credit score and lower debt-to-income ratio may also be required for such a product.
Conventional loans are not backed by the federal government.
Conforming and Non-Conforming Conventional Loans
When talking about conventional loans, you’ll hear two terms a lot: conforming and non-conforming. These terms refer to conforming to guidelines set by federal loan programs. Conforming loans meet these guidelines, while non-conforming do not.
Yes, we did just verify that conventional loans are not backed by the federal government. But, as scholars of the 2008 financial crisis will know, many conventional loans are sold in packages to government-sponsored enterprises (GSEs), including Freddie Mac and Fannie Mae. Lenders do this because they also need to comply with limits on how much lending they can make.
Though mortgage rules are complicated, what’s important for you to know is that conforming loans are below $510,401. Loans at or above this threshold are known as jumbo loans. Jumbo loans come with higher risk and higher interest rates. The higher risk and non-conformity make it harder for the lender to sell the mortgage on the secondary market, to GSEs for example.
If you’re buying in a major metropolitan area or another high-value area, be prepared to pay extra for your lending.
Conventional Loan Requirements Overview
Credit Score: 620, the higher the score the more favorable the loan. Some lenders prefer credit scores above 680.
Down Payment: 3 percent minimum, 20 percent to avoid mortgage insurance.
Income Limits: No income limits unless borrowing through Fannie Mae or Freddie Mac.
Debt-to-Income Ratio: 45 percent or less. Some borrowers with high credit scores may negotiate for a higher DTI ratio.
Mortgage Insurance: 0.15 to 2.5 percent of the loan amount paid annually depending on the borrower’s credit score.
Occupancy: Primary residence, second or vacation home, and investment properties.
Federal Housing Administration (FHA) Loans
Part of the Department of Housing and Urban Development (HUD), the Federal Housing Administration (FHA) offers several mortgage programs to first time home buyers. These programs can be great opportunities for low-income families or individuals with limited resources. The programs are meant to address economic disparities and revitalize communities by providing pathways to homeownership.
FHA loans have looser restrictions for credit score and down payments. Borrowers will also receive breaks for the upfront costs of lending. These looser rules make the loans easier to qualify for and, in some cases, cheaper than conventional lending.
The main drawback of using an FHA loan is that borrowers have to pay a mortgage insurance premium as part of their lending agreement. This amount will be paid in monthly installments until the borrower has sufficient home equity.
While mortgage insurance with FHA loans is less expensive than mortgage insurance for conventional loans, borrows should proceed with caution. The added costs add up quickly and can easily become more expensive than conventional lending.
FHA Loan Requirements Overview
Credit Score: 580 is the lowest score before requiring a higher down payment. 500 is the lowest acceptable credit score.
Down Payment: 3.5 percent of the purchase price. Credit scores between 500 and 579 are required to have a 10 percent down payment.
Income Limits: No income limits, but FHA loans cannot be larger than $331,760.
Debt-to-Income Ratio: 31 percent for housing costs and 43 percent for total debt.
Mortgage Insurance: Upfront mortgage insurance premium of 1.75 percent of the loan amount, plus 0.45 to 1.05 percent of the loan amount paid monthly for mortgage insurance premium.
Occupancy: Primary residence for at least the first year.
The Department of Veterans Affairs (VA) offers loans reserved for service members and veterans. To qualify for one, borrowers must show proof of service. Once they do, they’ll have access to generous lending opportunities. VA loans offer less strict credit and DTI ratio regulations. Borrowers can also opt to put less money down without the worry of paying for mortgage insurance. But keep in mind that low down payments may mean a higher interest rate.
VA loans typically won’t go higher than conforming conventional loan amounts. Additionally, the higher DTI limits aren’t necessarily in your favor. A higher DTI, while it may get you into a nicer home, ultimately means you’ll experience more economic stress. We recommend restraint with lending. The less you spend today, the more buying power you’ll have tomorrow.
VA Loan Requirements Overview
Credit Score: No official requirement, above 620 is recommended.
Down Payment: No official requirement, but your lender may have preferences.
Income Requirements: No official requirement, but your lender will have income requirements based on the amount of your loan.
Debt-to-Income Ratio: 41 percent recommended. Sometimes a higher DTI can be negotiated.
Mortgage Insurance: None required, mortgages are backed by the VA.
Occupancy: Primary residence only.