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Choosing the Best Type of Mortgage

Choosing the right type of loan when purchasing a home or investment property can be challenging. There are a lot of factors to consider, and the process can be a bit intimidating. In this article we break down mortgages into the two major types – those for investment properties and those for primary residences – and explore the many options within each of those categories. (And a couple that straddle both.)

So, strap on your home buying hat, and let’s get down to the nitty gritty of choosing the best type of mortgage.

Type of Loans for Home Buyers

One of the first questions a real estate lender will ask you is, “Are you intending for the purchased real estate to be your primary residence?” The reason that is important is because mortgages are different for borrowers purchasing a home to live in than they are for borrowers making an investment. In many cases entirely different kinds of loans are used, and for loan types that can be used in both cases, the eligibility requirements and terms vary, so it’s useful to organize mortgages types in this manner. 

Conventional Loans

Conventional loans are the most common type of real estate financing for traditional home buyers (and some investors). Available at most banks, credit unions, and alternative lenders, conventional home loans are not backed by the government. That having been said, most conventional loans are conforming loans, which means that they mimic the eligibility requirements and loan terms of government-insured programs. Offering conforming loans gives lenders the option to sell the loans to government programs like Fannie Mae and Freddie Mac. Loan terms are typically 15 to 30 years, require a down payment from 3 to 20 percent, and have strict credit requirements. The details of these terms, including the size of the down payment and minimum credit score required, will depend on whether the purchase is a first-home, single-family dwelling, or second home.

Government Insured Loans

Often the more attractive loan terms come from government-backed loans, where the participating government-funded program guarantees that the lender will be repaid for the loan even if the borrower defaults. In real estate loans that are fully or partially insured by government funds, lenders are able to offer lower interest rates, lower down payments, and more flexible eligibility requirements. The most common government-backed home loans include the following:

  • VA Loans – backed by the Department of Veteran Affairs, VA loans allow active-duty military personnel, veterans, and eligible family members to borrow funds with little or no down payment and no required mortgage insurance policy.
  • FHA loans – insured by the Federal Housing Administration, FHA loans are a great financing option for first-time homeowners or those with poor credit scores. The down payment required with FHA loans is directly related to the credit score of the borrower and can be as low as 3.5% with a credit score of 600 or above.
The top of the capital building, symbolic of government insured mortgage loans.
You don’t have to go to D.C. to get a government backed mortgage loan – you can get one right here in our beloved Orange County, CA.

Loans for Real Estate Investors

As noted, the financing options for those looking to purchase residential or commercial real estate for income generating purposes, like collecting rent or profiting from the resale of the property at an increased value (flipping), are in many cases different than the options available to regular homeowners. Generally speaking, the eligibility requirements for investors are stricter and may include higher down payments, higher credit scores, and may even include proof of property management experience. There are; however, a wide range of option available, as described below.

  • Owner financing – sellers have the option to act as a private lender to provide temporary financing to those looking to buy their home or building as an investment.  Typical terms of this type of financing include very high, non-refundable down payments and short-term repayment options.
  • Hard money financing – a popular type of loan for house flippers and other real estate investors, hard money loans come from investors expecting short repayment terms and generous returns on their investments. The financing costs for hard money loans are usually much higher than borrowers find through traditional financing methods.
  • Nonqualified mortgages (non-QM) – financing arrangements based on the projected future rental income of the property. Non-QM loans come with higher down payment requirements and above market interest rates but allow investors access to the funds needed to secure a purchase when faced with fewer options.
  • Home equity loans – borrowing funds against the equity in their primary residence is a popular way for real estate investors to get started. Home equity loans do not affect the current mortgage, but let borrowers take out a lump sum of cash to purchase additional real estate. Home equity loans typically have terms that include fixed interest rates and longer repayment schedules.
  • Conventional financing – like for residential homebuyers, conventional loans can be used by purchasers that don’t ever intend to live on the property. The credit and down payment requirements are often higher for investors, but conventional loans often offer better interest rates than less traditional types of funding.
  • VA multifamily loans – military investors can use funds backed by the U.S Department of Veteran Affairs, called VA joint loans or multifamily loans, to purchase multifamily properties with up to seven units. To qualify, borrowers must plan to live in one of the units full-time.
  • FHA loans – available for first-time homebuyers and other residential users, funds backed by the Federal Housing Administration can be used to buy multifamily properties with four or less units, as long as the borrower resides in one of the units for one year.
  • Cash-out financing – mortgages with a higher loan amount than the value of the purchased property – a common way for investors to finance the purchase of the home and fund repairs and renovations at the same time.

The Bottom Line

There are a wide range of options types available for those wishing to purchase real estate and choosing the best type of mortgage can be daunting. When thinking about these various types, it can be helpful to break them up between those typically used by investors, and those typically used by people looking to live in their homes. (Although there is some cross over, as discussed.) Regardless of your motivation, choosing the appropriate financing when purchasing housing is an important decision that shouldn’t be taken likely. Be sure to investigate all of your options and think carefully before taking the plunge. Good luck!

You may be wondering who we are? (We certainly wouldn’t blame you for doing so.) We’re My OC Bookkeeper. We provide bookkeeping and back office services to a wide range of clients, many of whom work in real estate. We’ve worked with realtors, Air BnB entrepreneurs, house flippers, the owners of small apartment complexes, and everything in between. So if you are interested in getting into real estate and need help with your books, reach out and let’s chat.

Interested in checking out another article on real estate? Try our post on Capitalizing vs. Expensing in Property Management or, take a look at our post on accounting methods used in property management.

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