Types of mortgage loans

There are two broad general categories into which mortgage loans in the U.S. can be classified: Conventional and Government Loans. To keep things simple, and because these two categories are the most commonly used, we will focus on these two major groups.

1. Government Loans: These loans are backed by a federal agency of the United States. There are three federal agencies that back mortgage loans; they insure the value of the loan, protecting the financial institution holding the debt in the event the borrower defaults on their obligations. These loans are often excellent resources for first-time homebuyers for their primary residence (as these programs are exclusively designated for owner-occupied properties). They require low down payments and allow for a higher Debt-to-Income (DTI) ratio.

• Federal Housing Administration (FHA): FHA loans are a premier resource for first-time buyers. The required down payment for 1-to-4 unit primary residences under this program is as low as 3.5%. To qualify for the 3.5% down payment, a credit score of at least 580 is required. In theory, an FHA loan can be obtained with a credit score as low as 500; however, the required down payment will be higher in such cases. This program also allows for the highest debt capacity among all government and conventional programs. Mortgage Insurance (MIP) is required regardless of the down payment amount.
• U.S. Department of Agriculture (USDA): The U.S. Department of Agriculture offers loans for the purchase of primary residences in certain designated rural areas. This program allows for 100% financing (0% down payment) and does not require traditional mortgage insurance*.
• Department of Veterans Affairs (VA): This loan is designed for current or former members of the military. It also offers the possibility of 100% financing and does not require monthly mortgage insurance.

2. Conventional Loans: Technically, "Conventional" refers to almost any mortgage loan not backed by the government—making it a very broad classification. However, in the vast majority of cases, "Conventional" refers to loans that follow the guidelines established by Fannie Mae and Freddie Mac, the two Government-Sponsored Enterprises (GSEs) created to promote credit flow in the economy.

Unlike government loans, these are not backed or insured by the federal government. Instead, they are typically insured by Private Mortgage Insurance (PMI) companies when the down payment is less than 20%. When the down payment exceeds 20%, the lender’s risk management determines that the equity in the property itself is sufficient to cover the obligation in case of default.

Conventional loans are divided into two types:

• Conforming: In addition to specific requirements regarding minimum down payments, property types, and credit scores, these loans must not exceed the loan limits established by Fannie Mae and Freddie Mac, which are updated annually. These loans are very common because the GSEs purchase them on the secondary market, allowing financial institutions to free up capital and continue originating new loans.

Product Types: This category includes Fixed-Rate Mortgages and Adjustable-Rate Mortgages (ARMs) with various terms such as 30, 25, 20, 15, and 10 years.

First-Time Buyers: There are programs with down payments as low as 3% for a 30-year term.

Insurance: PMI is required whenever the down payment is less than 20%.

• Non-Conforming Loans: These are loans that exceed the standard loan limits (often called Jumbo Loans) or do not follow Fannie/Freddie guidelines regarding down payment percentages, credit scores, or property types. These loans are not eligible for purchase by the GSEs.

Non-Qualifying Mortgages (Non-QM)

Because the Conventional category is so broad, it also includes a type of loan known as Non-QM. These loans use alternative methods to determine the viability of the debt.

• Alternative Documentation: In some cases, lenders use bank statements or Profit & Loss (P&L) statements to determine repayment capacity.
• Investment Properties: For investment properties, lenders may use a DSCR (Debt Service Coverage Ratio) approach, analyzing whether the property generates enough rental income to cover the mortgage payment. In these cases, the borrower may not need to provide personal income documentation, as the analysis focuses solely on the property’s cash flow.

Summary: This is a general overview of mortgage types and their classification in the United States. The most important takeaway is that there are many options available when it comes to buying a home or investing in real estate.

*Generally, when a down payment is less than 20%, mortgage insurance is required to protect the lender in the event of default.