How to choose the best mortgage and decide between conventional or government-backed, fixed or adjustable rate

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• When choosing a mortgage, you'll likely decide between a conventional or a government-backed loan.
• Conforming loans meet standards set by the FHFA, but nonconforming loans surpass that limit.
• A fixed-rate mortgage keeps your rate for your entire loan, while an ARM changes it automatically.

Buying a home is a huge life step. But there's another major step you have to take first: Deciding which type of mortgage you want to apply for.

Your decision may ikely come down to which types of mortgage you qualify for. But there's a little strategy involved that could ensure that you are making the best decision for your future. 

1. Conventional mortgage vs government-backed mortgage

The first decision you'll have to make is probably whether you want a conventional or government-backed mortgage.

A conventional mortgage is a loan from a private lender, or from federal companies Freddie Mac or Fannie Mae. Conventional mortgages aren't insured by the government, and depending on the lender, you'll need a certain credit score, down payment, and debt-to-income ratio to receive a mortgage.

In many cases, government-backed mortgages are for people who don't qualify for a conventional mortgage. They can also be for specific groups of people, such as military veterans or people with low-to-moderate incomes.

You'll still apply for a government-backed loan through a private company, but it will be insured by the government. This makes it less risky for lenders to give you a loan if you don't meet conventional loan requirements.

If you have a good credit score, some money for a down payment, and a debt-to-income ratio of 36% or less, you might want a conventional loan.

Otherwise, you can look at government-backed mortgages. These can be great mortgage options, but some are only for specific groups of people. Some also come with drawbacks, including borrowing limits and higher mortgage insurance premiums.

2. Conforming vs nonconforming mortgages

If you're looking at conventional mortgages, you'll choose between either a conforming or nonconforming loan. The main difference between these two types is the amount of money you need to borrow.

A conforming mortgage meets the standards set by the Federal Housing Finance Agency (FHFA). The FHFA sets the limit for conforming loans every year. In 2023, the limit is $726,200 in most parts of the US. In areas with a higher cost of living, the limit goes up to a ceiling of $1,089,300.

A nonconforming mortgage is for an amount that exceeds the FHFA limit. You also might hear it referred to as a jumbo loan.

To qualify for a nonconforming mortgage, you'll likely need a higher credit score, bigger down payment, and lower debt-to-income ratio than you would for a conforming loan.

If you need more money than allowed by the FHFA and can qualify for the loan, then a nonconforming mortgage may be for you. If not, then you'll want to go with a conforming mortgage.

3. Government-backed mortgages: FHA, VA, or USDA loan

Government-backed mortgages are issued by the federal government. They typically have looser requirements surrounding credit scores, down payments, and debt-to-income ratios.

You'll still go to a private lender to get a government-backed loan, but you should specify that you want a government-issued mortgage.

There are three common types of government-backed loans:

• Veterans Affairs (VA) loans: You may be eligible if you're affiliated with the military.
• United States Department of Agriculture (USDA) loans: You must have a low-to-moderate income level and buy a home in a rural or suburban area.
• Federal Housing Administration (FHA) loans: You may qualify if you aren't eligible for a VA loan or USDA loan, but would likely need to have more saved for a down payment than you would for the others. Many VA and USDA loans don't require a down payment at all. With an FHA loan, you'll need a 3.5% down. FHA loans also require a 1.75% mortgage premium upfront, and you'll keep paying a smaller premium each year.

4. Fixed-rate vs adjustable-rate mortgages

Once you've decided on which type of conventional or government-backed loan you need, you have to choose between two more types of mortgages: fixed-rate or adjustable-rate loans. These two options have to do with the interest you pay on your loan.

A fixed-rate mortgage locks in your rate for the entire life of your loan. Although US mortgage rates tend to fluctuate, you'll still pay the same interest rate in 30 years as you did on your very first mortgage payment. The most common term length for a fixed-rate mortgage is 30 years, but there are also other term lengths, like 20 or 15 years.

An adjustable-rate mortgage, or ARM, keeps your rate the same for the first few years, then periodically changes around once per year.

With an ARM, there's an "initial rate period," which means that your rate will stay the same for a set amount of a few years. Then, it will change periodically.

For example, if you have a 5/1 ARM, your introductory rate period is five years, and your rate will go up or down once a year for 25 years. Most lenders offer 7/1 or 5/1 ARMs, but different lenders offer various terms.

Adjustable rates are starting lower than fixed rates right now. You may want to consider getting an adjustable-rate mortgage if you're only planning on living in your home for a couple of years, because you can get a lower rate without risking it increasing later.

If you're ready to settle down and buy your forever home, fixed-rate mortgages might be a more suitable choice. This way, you'll know how much you'll pay every month for the long term. And if rates drop, you have the option to refinance for a lower rate.