4 Types of Conventional Mortgages
Understanding what key terms like "conventional mortgage" mean can help buyers choose the right loan for their situation and the home that they want. A conventional mortgage is any mortgage that is not guaranteed or insured by the government. However, that does not make all conventional loans alike. There are a number of types of conventional mortgages, and each will have pros and cons for potential homeowners.
Conforming and Nonconforming Conventional Loans
The first choice that most borrowers who are researching conventional loans will come across is a conforming versus a nonconforming loan. Which the borrower will apply for will typically come down to the type of home being purchased and the size of the loan.
A conforming loan is one that meets the loan standards set by Freddie Mac and Fannie Mae and the maximum loan limits set by the Federal Housing Finance Agency. Nonconforming loans are those that use different underwriting standards or that go over the maximum loan limits.
In most counties in the U.S., a loan that is over $484,350 will be considered a nonconforming loan. These loans are known as jumbo loans and have strict requirements when it comes to a borrower's income, credit, and savings.
Fixed-Rate versus Adjustable-Rate Mortgages
A fixed-rate loan is one that has the same interest rate throughout the loan term. Many buyers like this option because it means that the loan payment is predictable throughout the life of the loan. However, the downside is that buyers with this type of loan may be paying higher interest rates if they decrease.
An adjustable-rate mortgage (ARM) is a mortgage where the interest rate varies throughout the life of the loan. In most cases, the interest rate is low for the introductory period of the loan. Introductory periods can last anywhere from several months to several years. After this period, the interest rates are tied to the index interest rate. The interest rate will often change once a year. While this type of loan can save money during the introductory period, it can lead to unpredictable or high payments later on in the loan.
80/20 Loans or Low Down Payment
Conventional loans are also categorized by what sort of down payment is required. For many years, the most common type of home loan required that borrowers put down 20% of the value of the home then financed the other 80%. Because of this, they were called 80/20 loans. Lenders felt that the ability to amass a down payment of that size showed that the borrower was dependable. Loans with a higher down payment are often offered at lower interest rates.
Buyers who are unable to provide a 20% down payment do have other options. There are loans available that offer down payments as low as 3% for buyers who meet certain qualifications. In most cases, a buyer who is putting down less than 20% will also have to pay for private mortgage insurance (PMI) to secure the loan. Lower down payment loans are often referred to by the split between the down payment and how much the borrower finances. For instance, a 5% down payment loan may be referred to as a "conventional 95 mortgage" or a "5 down" loan.
15- or 30-Year Loans
Buyers considering conventional loans will also have to decide their mortgage term. Thirty-year loans are the most common term, as they allow for smaller monthly payments, which most buyers find more manageable.
Many buyers also have the option of choosing a 15-year loan instead. Mortgages of this term will generally have higher monthly payments. However, the trade off is that borrowers with these loans will typically pay less interest over the life of the loan.
There is no one answer that is right for every borrower when it comes to home loans. Each prospective homeowner should compare the terms of the loan, the cash out of pocket and other factors to see which options will work best for their specific situation. By making sure they understand all the terms and their implications, borrowers can pick the loan that will allow them to purchase the perfect home for their futures.