Types of Conventional Loans for Homebuyers
Mortgage brokers carry a vast array of products, including those tired and boring old conventional loans. A bank can make a conventional loan, too, but a bank's product line is generally limited and particular to only that bank. A mortgage broker can broker loans through any number of banks.
Many of the exotic types of loans vanished after the mortgage meltdown of 2007 but conventional loans were still there and, in fact, they regained a prominent position in real estate markets. Conventional loans enjoy a reputation for being safe, and there is a variety to choose from.
How Conventional Loans Are Different
The main difference between a conventional loan and other types of mortgages is that a conventional loan isn't made by or insured by a government entity. They're also sometimes referred to as non-GSE loans—not a non-government sponsored entity.
Conventional loans aren't particularly generous or creative when it comes to credit score flaws, loan-to-value ratios, or down payments. There's generally not a lot of wiggle room here when it comes to qualifying. They are what they are.
Government loans include FHA and VA loans. An FHA loan is insured by the government and a VA loan is backed by the government. Down payment requirements are much more buyer-friendly. The minimum down payment for an FHA loan is 3.5 percent. The minimum down payment can be zero for VA loans to qualifying veterans.
Conventional "Portfolio" Loans
These are a subset of conventional loans that are held directly by mortgage lenders. They're not sold to investors as other conventional loans are. Lenders can, therefore, set their own guidelines for these mortgages and this can sometimes make it a little easier for borrowers to qualify.
Sub-Prime Conventional Loans
Like other industries, mortgage lenders have been known to offer a special class of loans to borrowers with iffy or even poor credit. The government sets guidelines for the marketing of these "sub-prime" loans, but that's the beginning and end of any government involvement. These, too, are conventional loans and the interest rates and associated fees are often quite high.
Amortized Conventional Loans
Homebuyers can take out an amortized conventional loan from a bank, a savings and loan, a credit union, or even through a mortgage broker that funds its own loans or brokers them. Two important factors are the term of the loan and the loan-to-value ratio:
- 97 percent LTV with a common 30-year term (or 20, 15 or 10)
- 95 percent LTV with a common 30-year term (or 20, 15 or 10)
- 90 percent LTV with a common 30-year term (or 20, 15 or 10)
- 85 percent LTV with a common 30-year term (or 20, 15 or 10)
- 80 percent LTV with a common 30-year term (or 20, 15 or 10)
The loan-to-value ratio indicates how much the loan represents of the property's value. A $200,000 mortgage against a property that appraises for $250,000 results in an LTV of 80 percent: the $200,000 mortgage divided by the $250,000 value.
The LTV can be less than 80 percent, but lenders require that borrowers pay for private mortgage insurance when the LTV is greater than 80 percent. Some conventional loan products allow the lender to pay for private mortgage insurance, but this is rare.
The term of the loan can be longer or shorter, depending on the borrower's qualifications. For example, a borrower might qualify for a 40-year term, which would significantly lower the payments. A 20-year loan would raise the payments.
For example, that $200,000 loan at 6 percent payable over 20 years would result in payments of $1,432.86 per month, whereas a $200,000 loan at 6 percent payable over 30 years would result in a payment of $1,199.10 per month. A $200,000 loan at 6 percent payable over 40 years would result in a payment of $1,100.43 per month.
A fully amortized conventional loan is a mortgage in which the same amount of principal and interest is paid every month from the beginning of the loan to the end. The last payment pays off the loan in full. There is no balloon payment.
Conforming loans—those that conform to GSE guidelines—are limited to $453,100 as of 2018. This number can be adjusted annually. A minimum credit score for a good interest rate is typically higher than those required for FHA loans.
Loan limits above $453,100 are considered to be agency loans and are sometimes referred to as non-conforming loans. Some are jumbo loans and the interest rates are typically higher here, too.
Adjustable Conventional Loans
Payments on an adjustable rate conventional loan means can fluctuate because the interest rate is adjusted periodically to keep pace with the economy.
Some loans are fixed for a certain period of time, then they turn into adjustable rate loans. For example, a 3/1 30-year ARM is fixed for three years, then it begins to adjust for the remaining 27 years. A 5/1 ARM is fixed for the first five years. A 7/1 ARM is fixed for seven years before it begins to adjust.
Features of an Adjustable Conventional Loan
Many borrowers shy away from adjustable rate conventional loans. They prefer to stick with traditional amortized loans so there are no surprises with regard to mortgage payments that will come due down the road. But an adjustable rate mortgage might be just the ticket to help with the early years of payments for borrowers whose incomes can be expected to increase.
The initial interest rate is typically lower than the rate for a fixed-rate loan and there's usually a maximum, known as a cap rate, on how much the loan can adjust over its lifetime. The interest rate is determined by adding a margin rate to the index rate. Adjustment periods can be monthly, quarterly, every six months, or every year.
At the time of writing, Elizabeth Weintraub, CalBRE #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.