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Motley Fool Money's Complete Guide to Mortgages

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Nathan Alderman
Fact Checked: Nathan Alderman
Nathan Alderman
Nathan Alderman
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Nathan Alderman has been a full-time Motley Fool employee since 2005, making errors his arch-enemies in a variety of roles including a six-year stint as the dedicated fact-checker for The Motley Fool's premium newsletter services. As Motley Fool Money's Compliance Lead, he makes sure that all the site's information is accurate and up to date, which ensures we always steer readers right and keeps various financial partners happy. A graduate of Northwestern University's Medill School of Journalism, Nathan spends his spare time volunteering for civic causes, writing and podcasting for fun, adoring his wife, and wrangling his two very large young children.

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Getting a mortgage is a big decision. With all of the potential options on the market, where do you even start? If you're a first-time home buyer looking for the best lender for you or a homeowner looking to refinance, we've got you covered.

What is a mortgage?

A mortgage is a loan designed to help you buy a home, typically repaid over an extended period, often 15 or 30 years. Since it’s secured by the home itself, falling behind on payments could lead to foreclosure, where the lender takes ownership of the property.c

Mortgages come in various types, such as conventional loans, which aren’t backed by government agencies, and government-guaranteed loans supported by the FHA, VA, or USDA. Both types are offered by private lenders, including banks, credit unions, and online platforms.

Loans can also be classified as conforming or non-conforming. Conforming loans meet the Federal Housing Finance Agency's limits and can be sold by lenders to government-sponsored enterprises like Fannie Mae and Freddie Mac. Non-conforming loans, or jumbo loans, exceed these limits and cater to higher-priced properties.

If you are new to the world of mortgages, check out our beginner's guide to home loans.

Types of mortgages

Mortgages serve the same purpose—helping you finance a home purchase—but they vary in their requirements and approval processes. Here are the primary types of home loans offered by most lenders.

Conventional mortgages

Conventional home loans follow borrowing limits established by Fannie Mae and Freddie Mac, the agencies that support most U.S. mortgages. If your down payment is below 20%, you’ll be required to pay private mortgage insurance (PMI). However, some conventional loans allow down payments as low as 3%. These borrowing limits are adjusted annually.

Jumbo mortgages

These are conventional mortgages that exceed the maximum borrowing limits. Jumbo mortgages are harder to qualify for than conventional mortgages, and you'll generally need at least a 10% down payment, if not 20%.

FHA loans

FHA loans, backed by the Federal Housing Administration, are designed for borrowers with less-than-perfect credit or limited savings for a down payment. With a credit score of 580 or higher, you can qualify with a down payment as low as 3.5%. However, FHA loans require mortgage insurance premiums (similar to PMI) and an FHA-specific appraisal, which might extend your closing timeline.

VA loans

VA loans are available to active members of the U.S. military as well as veterans. VA loans don't require a down payment, have competitive interest rates, and don't charge PMI. There are, however, funding fees involved that get tacked onto your mortgage costs, and you'll need to get a VA-specific appraisal. Due to its multiple benefits, a VA loan is often a good idea for service members and veterans.

USDA loans

Backed by the U.S. Department of Agriculture, USDA loans help lower-income borrowers buy homes in rural areas. If you qualify, you won't have to make a down payment on your home, but the home must be located in a designated zone (buying in a suburb alone does not guarantee that you'll qualify).

Mortgage lenders and financing

To get a mortgage, you must find a mortgage lender to finance your home purchase. Doing so is not always easy, as the application process can be lengthy, and the decision fraught with emotion.

Luckily, our experts have you covered and have curated a list of the best mortgage lenders.

Mortgage refinancing

If you currently have a mortgage, refinancing could offer significant benefits. Let’s explore what refinancing entails and identify which type might work best for your situation.

What does it mean to refinance a mortgage?

In the financial world, the term refinancing means using a new loan to replace an existing one. So, refinancing a mortgage means obtaining a brand-new mortgage to replace your current one. Refinances are generally done to improve the terms of your mortgage or save money on interest by getting a lower mortgage rate. You may also want to cash out some of your equity by borrowing via one of the best home equity loan lenders.

Types of refinancing

There are several types of refinancing loans, but most fall into these broad categories:

  • Rate and/or term refinancing: This is a "standard" refinance. Essentially, this involves replacing your existing mortgage with another for the same principal amount, with the goal of lowering your interest rate or changing your loan term length.
  • FHA refinancing: FHA mortgages can be a good idea to open the door to homeownership but aren't as beneficial after the homeowner has built up significant equity. There are streamlined FHA mortgage refinancing programs designed to quickly and easily refinance these loans for borrowers who would benefit from such a move.
  • Cash-out refinancing: Another type of refinancing loan, called a cash-out refinance, allows homeowners to take cash out of their property's equity.

How are mortgage rates determined?

Borrowers applying for a mortgage loan should compare rates and terms among multiple lenders because mortgage rates can vary substantially. Each individual lender uses both economic factors and the borrower's credentials to set rates.

Today's Mortgage Rates Today's Mortgage Refinance Rates Today's 15-Year Mortgage Rates Today's 30-Year Mortgage Rates

Mortgage rates are affected by the federal funds rate, which is the rate set by the Federal Reserve (the U.S. central bank). Banks use the federal funds rate when making overnight loans to other banks. Rates are also affected by what investors are willing to pay for mortgage-backed securities, which are groups of mortgage loans put together by institutional investors who buy loans on the secondary mortgage market. Because investors looking for fixed-income investments tend to compare mortgage-backed securities with 10-year Treasury yields, the Treasury yield affects rates as well.

The financial credentials of each individual borrower also have an impact on what rates will be available. Lenders price loans based on the perceived level of risk that a particular borrower won't pay back their debt. Some of the factors lenders consider when setting rates for individual borrowers include:

  • Credit Score: Borrowers with higher credit scores qualify for lower interest rates, as they represent less risk to lenders.
  • Debt-to-Income Ratio (DTI): This compares a borrower’s total debt payments (including the mortgage) to their income. A lower DTI signals lower risk, resulting in more favorable interest rates.
  • Down Payment Size: Larger down payments lower the lender's risk, as they reduce the chance of losses in case of foreclosure. Additionally, more equity in the home often motivates homeowners to avoid defaulting.
  • Loan Term: Shorter-term loans, like 15-year mortgages, generally come with lower interest rates compared to 30-year loans due to the reduced repayment period.
  • Employment History: A stable job history assures lenders of consistent income, reducing the risk of missed payments and leading to better loan terms.

While you cannot change the broad macroeconomic factors that affect your rate, you can take steps to lower it by improving your credit, saving for a larger down payment, and choosing a mortgage with a shorter loan repayment term.

To understand how mortgage rates change your monthly mortgage payment, check out our mortgage calculator.

Fixed-rate vs. adjustable-rate mortgages

Mortgages come in two main varieties: fixed-rate and adjustable-rate mortgages (ARMs).

  • Fixed-Rate Mortgages:
    With a fixed-rate mortgage, the interest rate remains constant throughout the loan term. This ensures predictable monthly payments and allows borrowers to know the total loan cost upfront.
  • Adjustable-Rate Mortgages (ARMs):
    ARMs start with a fixed rate for a set period, after which the rate adjusts periodically. For example:
    • A 3/1 ARM has a fixed rate for the first three years, adjusting annually afterward.
    • A 5/1 ARM offers a fixed rate for five years before annual adjustments.
      ARMs typically begin with lower interest rates compared to fixed-rate loans, making them appealing for borrowers looking to save on initial costs or qualify for a higher-priced home.

Pros and Cons of ARMs:

  • Pros:
    • Lower initial rates result in smaller monthly payments and reduced interest costs during the fixed period.
  • Cons:
    • After the fixed period, rates adjust based on a financial index, potentially increasing significantly. This can lead to unaffordable payments if rates rise steeply.

Borrowers often plan to refinance or sell before rate adjustments, but market downturns or falling home values can hinder those plans.

If considering an ARM, carefully review disclosures to understand the maximum potential rate and payment. If that worst-case payment isn’t manageable, be aware of the risks involved.

Why your credit score matters when buying a house

Credit scores help lenders see how creditworthy you are, that is, how well you pay back debt on time. Often, lenders will give more favorable interest rates to borrowers with higher scores simply because they perceive less risk in the transaction.

That said, there's no minimum credit score required for VA mortgages insured by the U.S. Department of Veterans Affairs, as lenders are instructed to take a borrower's full financial profile into account. But even with VA loans, some mortgage lenders may still impose their own credit score minimum.

Minimum Credit Score Requirements for Mortgage Loans

Different types of mortgage loans have specific credit score requirements:

  • FHA Loans:
    • Minimum credit score of 580 for a 3.5% down payment.
    • Scores as low as 500 may qualify with a 10% down payment.
  • Conventional Loans:
    • Typically require a credit score of at least 620, especially with a substantial down payment and low debt-to-income ratio.
    • To secure the most competitive rates, you’ll generally need a score of 740 or higher

FAQs

  • To get the best mortgage for you, you should increase your credit score, pay down your debt to improve your debt-to-income ratio, choose a shorter loan term, and make a larger down payment.

  • Banks are one type of mortgage lender, but there are also non-bank lenders whose sole business purpose is offering mortgage loans. There are pros and cons to both banks and mortgage lenders.

    Banks often have stricter qualifying requirements, may charge more fees because of added compliance requirements, and may take longer in their underwriting. But you may also be eligible for relationship discounts if you make use of their other banking services. For example, bank customers may get a discount on closing costs or a reduction in their interest rate if they set up mortgage autopay linked to their checking account with the same bank.

    Dedicated mortgage lenders, on the other hand, often make it faster and easier to qualify for a loan. However, many do not have a physical branch where you can go for customer service. And there's also a greater chance the mortgage lender will sell your loan to another loan servicer after you close on it.

    Another option is to find a lender through a mortgage broker. Mortgage brokers are intermediaries who compare rates and find lenders who can best fulfill your needs. Brokers may help you save time by examining your income and employment and helping you decide what mortgage you should apply for. They're not always the best option -- especially if they charge you (and not the lender) a fee -- but in some cases, a broker can simplify the mortgage process and get you a competitive rate.

  • Ideally, you should make a 20% down payment. This would enable you to qualify for a conventional loan with fewer fees and no private mortgage insurance required. Putting 20% down also reduces the likelihood you'll end up owing more than your home is worth, so it can be easier to get approved for a loan. You may also be charged a lower interest rate if you put more money down.

    If you cannot afford a 20% down payment, some conventional lenders allow you to put down as little as 3%. While it is sometimes possible to find special programs that waive private mortgage insurance, it is almost always required on conventional loans when you put less than 20% down.

    Government-backed loans also allow for lower down payments. The VA doesn't require any minimum down payment unless the home is worth less than you're buying it for and there's no private mortgage insurance required. However, there is an upfront mortgage loan fee equal to a percentage of the borrowed amount. FHA loans enable you to buy with as little as 3.5% down, but you then pay mortgage insurance for the life of the loan.