Buyers can easily get overwhelmed by the options they are confronted with when it is time to apply for a loan. Conventional? Government-backed? Fixed rate? Adjustable rate? Even within these categories there can be several options.
Let’s start with the basics
Fixed Rate Mortgage
In this type of mortgage, the mortgage interest rate remains fixed for the life of the loan. Monthly payments are fixed (for the principal and interest). If property taxes and homeowner’s insurance are paid as part of your payment, these are paid through an “escrow” account which can fluctuate from year to year.
Adjustable Rate Mortgage
These are also called ARMs. ARMs generally start out with a lower interest rate than a fixed rate loan.
This type of loan has the potential to have monthly payments that change since the interest rate can change. There is usually an initial period of time where the interest rate does not adjust – usually between 3-5 years. How often the interest rate adjusts will also depend on the loan. Since interest rates do change over time, the payment can either be higher or lower depending on the difference in the interest rate. For example, if someone took out a loan when interest rates were at record-low levels, it is unlikely that interest rates will continue to be this low when the interest rate adjusts.
Mortgages may also be either “conventional” (meaning funded by the private sector – usually a bank) or a “government-backed” loan. Government-backed loans are backed by the federal government, including the Department of Veteran Affairs or the Department of Housing and Urban Development. The government agency is “insuring” the loan, although the funding may still be by a bank.
So why the two different types of loans? The Department of Housing and Urban Development typically has less-stringent lending qualifications, making it easier for some buyers to get a loan. For example, at the time of this writing, the down payment on an FHA loan (by the Federal Housing Administration) can be as low as 3.5% as opposed to a private loan which require 10-20%.
FHA loans, VA loans, and USDA loans are all examples of government-backed loans.