Purchasing a home is one of the biggest decisions that you will make in your lifetime, so it is important that you do so with the loan that is best for you. There a numerous loans out there, including conventional mortgage loans, and each with its out set of pros and cons. This article will discuss those of the conventional mortgage.
What is a Conventional Mortgage?
A conventional mortgage is a loan for the purchase of a home that is not guaranteed or insured by the federal government (like a VA or FHA loan is). A conventional mortgage is set by limits set forth by Freddie Mac and Fannie Mae (two government-controlled companies that provide money for the U.S. housing market). Conventional mortgages are available at a fixed or adjustable rate.
In a mortgage with a fixed rate, the rate of interest remains the same throughout the tenure of the mortgage loan. They can be useful for first-time buyers, or anyone whose mortgage obligation represents a significant percentage of their earnings. The benefit of knowing the level of mortgage repayment is more important than any advantage gained from decreasing interest rates.
An adjustable-rate mortgage, or ARM, is a mortgage loan in which the interest rate is periodically adjusted based on a variety of factors. However, it is common for these rates to be adjusted upwardly, especially when the housing market isn’t making as much money. It is also common to see a change in rate around the 5 year mark.
Since conventional mortgages are not guaranteed or insured by the federal government, the loans are typically offered by banks, credit unions, savings institutions, and private lenders. Conventional mortgages pose a higher risk for lenders, because if the buyer defaults on their payments at any point in the loan, it is hard for the lender to get that money back.
Conventional mortgages are available in 15, 20, or 30 year terms and because it’s risk to lenders, they require larger down payments (5% is the minimum, but 20% is the norm). This means that it is usually more appealing for those who are more financially secure or with good credit – although anyone can apply for the loan.
In addition, borrowers are responsible for origination fees, mortgage insurance, and appraisal fees, making the conventional mortgage a higher out-of-pocket loan option.
Conventional mortgages fall into two categories: “conforming” and “non-conforming” loans.
These versions of the loan follow the guidelines set by Fannie Mae and Freddie Mac.One such guideline is the size of the loan. Since 2016, single-family home loans for most of the continental U.S. are limited to $417,000.
These loans are often called jumbo loans, and typically are for borrowers who don’t qualify for a conforming loan (usually because the home value is higher than the limit), or are made to borrowers with poor credit, are high in debt, or recovering from a bankruptcy. Non-conforming loans are a major risk for lenders and are harder to sell on the “secondary market”. Secondary market is where your original lender turns around to sell your loan to another financial institution. Because of the associated risk and difficulty in re-selling your loan, non-conforming conventional loans come with higher interest rates and may also include additional fees.
Overall, if you are in the market and have a strong credit history or a sizeable down payment, then a conventional mortgage may be the loan for you. However, if you do not fall into that category, then other loans such as the FHA or USDA may be a better option for you.