The Main Types of Mortgages and How They Work

Fixed-Rate vs. Adjustable-Rate: The Core Difference

A fixed-rate mortgage locks your interest rate for the entire loan — usually 15, 20, or 30 years. Your monthly payment stays the same from the first month to the last. An adjustable-rate mortgage (ARM) starts with a lower rate that changes after a set period, typically 3, 5, 7, or 10 years. After that initial period, your rate adjusts annually or semi-annually based on market conditions, which means your payment can go up or down.

Fixed-rate mortgages are simpler to budget for because you know exactly what you'll pay each month. Adjustable-rate mortgages can save you money in the short term if rates stay low, but they carry the risk that your payment will increase significantly when the rate adjusts. Most homebuyers choose fixed-rate mortgages because the predictability outweighs the initial savings of an ARM.

Key Takeaways

• Fixed-rate mortgages keep the same interest rate and payment for the life of the loan, while adjustable-rate mortgages start low and change after an initial period.
• Conventional mortgages require a down payment (often 5 to 20 percent) and are not backed by the government, while FHA, VA, and USDA mortgages are government-backed and have different down payment and credit requirements.
• Jumbo mortgages are for homes that exceed the conventional loan limit in your area, typically requiring larger down payments and higher credit scores.
• Interest-only mortgages let you pay only interest for a set period, lowering your initial payment but leaving you with a larger balance when the principal payments begin.
• Your choice depends on how long you plan to stay in the home, your risk tolerance, and your current financial situation.

Conventional Mortgages and Government-Backed Loans

A conventional mortgage is a loan from a private lender that is not backed by any government agency. You typically need a down payment of at least 5 percent, though 10 to 20 percent is common. Conventional loans require a credit score of at least 620, though most lenders prefer 680 or higher. If your down payment is less than 20 percent, you'll pay private mortgage insurance (PMI), which protects the lender if you default.

FHA mortgages are backed by the Federal Housing Administration and allow down payments as low as 3.5 percent. They accept credit scores as low as 580 and are designed for first-time homebuyers or those with limited savings. FHA loans require mortgage insurance for the life of the loan (if your down payment is less than 10 percent) or for at least 11 years.

VA mortgages are available to active-duty military, veterans, and surviving spouses. They require no down payment and no mortgage insurance. VA loans typically have lower interest rates than conventional mortgages because the Department of Veterans Affairs guarantees the loan.

USDA mortgages are for rural homebuyers who meet income limits. They require no down payment and no mortgage insurance. USDA loans are backed by the U.S. Department of Agriculture and are designed to encourage homeownership in areas outside cities and suburbs.

Jumbo Mortgages for High-Value Homes

A jumbo mortgage is a conventional loan that exceeds the conforming loan limit set by Fannie Mae and Freddie Mac. This limit varies by county but is typically around $766,550 in most areas as of 2024. Jumbo loans are for homes priced above that threshold and are common in high-cost markets.

Jumbo mortgages usually require a larger down payment (often 10 to 20 percent or more), a higher credit score (typically 700 or above), and proof of substantial savings or assets. Interest rates on jumbo loans may be slightly higher than conventional mortgages because the lender is taking on more risk. Jumbo loans are not backed by Fannie Mae or Freddie Mac, so the terms and requirements vary more widely between lenders.

Interest-Only Mortgages and Balloon Loans

An interest-only mortgage lets you pay only the interest on the loan for a set period, typically 5 to 10 years. Your monthly payment is lower during this time because you're not building equity. After the interest-only period ends, your payment increases significantly because you begin paying down the principal, and you have fewer years left to repay the remaining balance.

Interest-only mortgages are risky for most homebuyers because the payment shock when the principal payments begin can be severe. They work only if you're confident your income will increase or you plan to refinance or sell before the interest-only period ends. If home values drop or interest rates rise, you could be stuck with a payment you can't afford.

A balloon mortgage works similarly: you make low payments for a set period (often 5 to 7 years), then owe a large lump sum at the end. Balloon mortgages are uncommon in residential real estate because the final payment is difficult for most homebuyers to manage. They're more common in commercial real estate or for borrowers who are certain they'll sell or refinance before the balloon payment is due.

Shorter Loan Terms: 15-Year vs. 30-Year Mortgages

Most mortgages are either 15-year or 30-year loans. A 15-year mortgage has a higher monthly payment but you pay significantly less interest over the life of the loan and build equity faster. A 30-year mortgage has a lower monthly payment, which makes homeownership more affordable for most people, but you pay more interest overall.

The choice between 15 and 30 years depends on your budget and goals. If you can comfortably afford the higher payment and want to pay off your home faster, a 15-year mortgage saves you money. If you need the lower payment to may have access to for the loan or to leave room in your budget for other expenses, a 30-year mortgage is the right choice. Some borrowers choose a 30-year mortgage but make extra payments toward principal when they can, giving them flexibility without locking in a higher payment.

Adjustable-Rate Mortgages: When the Rate Changes

An adjustable-rate mortgage (ARM) typically starts with a lower interest rate than a fixed-rate mortgage for an initial period called the "teaser rate." This period might last 3, 5, 7, or 10 years. After that, the rate adjusts periodically — usually once a year — based on a market index plus a margin set by the lender.

ARMs include rate caps that limit how much your rate can increase at each adjustment and over the life of the loan. For example, your rate might be capped at a 2 percent increase per adjustment and a 6 percent increase over the life of the loan. Even with these caps, your payment can increase substantially. If you take out a $300,000 ARM at 3 percent and the rate jumps to 6 percent after five years, your monthly payment could increase by $600 or more.

ARMs make sense only if you're confident you'll sell or refinance before the rate adjusts, or if you can afford the payment at the highest possible rate. Most homebuyers are better served by a fixed-rate mortgage because the predictability reduces financial stress and the risk of payment shock.

Specialized Mortgages: Construction and Portfolio Loans

A construction mortgage finances the building of a new home. During construction, you typically pay only interest on the amount borrowed so far. Once construction is complete, the loan converts to a standard mortgage (usually a fixed-rate loan). Construction mortgages are more complex and carry more risk because the final cost of the home may not be known at the start.

A portfolio mortgage is held by the lender rather than sold to Fannie Mae or Freddie Mac. Portfolio mortgages are less common and typically available only through banks or credit unions. They may have different terms and requirements than conventional mortgages, and they're often used for borrowers who don't fit standard lending criteria — for example, self-employed borrowers with irregular income or those with recent credit problems.

Frequently Asked Questions

What's the difference between a fixed-rate and adjustable-rate mortgage?

A fixed-rate mortgage keeps the same interest rate and payment for the entire loan term. An adjustable-rate mortgage starts with a lower rate that changes after an initial period, usually 3 to 10 years. After that, your rate and payment adjust annually or semi-annually based on market conditions.

Which mortgage type is best for first-time homebuyers?

Most first-time homebuyers choose a 30-year fixed-rate conventional or FHA mortgage because the payment is affordable and predictable. FHA mortgages are specifically designed for first-time buyers and allow down payments as low as 3.5 percent. A fixed rate removes the risk of payment increases later.

Can I get a mortgage with no down payment?

Yes, if you're may be able to access. VA mortgages require no down payment for military members and veterans. USDA mortgages require no down payment for rural homebuyers who meet income limits. Conventional mortgages typically require at least 3 to 5 percent down, though some lenders offer 0 percent down programs with higher interest rates or additional fees.

What happens if I can't afford my payment when an ARM adjusts?

If your adjustable-rate mortgage payment increases beyond what you can afford, you can try to refinance into a fixed-rate mortgage, though this depends on your credit, income, and home value at that time. If refinancing isn't possible, you may face payment shock and difficulty making your mortgage payment. This is why ARMs carry significant risk for most homebuyers.

Is a 15-year mortgage always better than a 30-year mortgage?

A 15-year mortgage saves you money on interest and builds equity faster, but the monthly payment is significantly higher. A 30-year mortgage is more affordable for most people and leaves room in the budget for other expenses. The better choice depends on your income, expenses, and financial goals, not on the loan term alone.