A conventional mortgage is a home loan that is not backed by the federal government in any way. Also known as a “conforming” mortgage, conventional loans follow the guidelines set by Freddie Mac and Fannie Mae, which are major institutions in the secondary mortgage market.
Conventional mortgages allow down payments as small as 3% of the home purchase price. Mortgage insurance is required when the down payment is less than 20%, but it may be waived in the future, once equity conditions are met.
Typically, conventional mortgages offer very competitive interest rates. However, they are less forgiving when it comes to credit scores, and can be more difficult to qualify for than government-backed loans.
Loans backed by the Federal Housing Administration are designed to make home ownership more widely attainable. These loans offer down payments as low as 3.5% and up to a 6% seller concession. Cash gifts may also be used for the down payment provided the mortgage underwriter can determine that the funds were not from an unacceptable source and the funds can be traced from the source to the home buyer. FHA loans have lower credit score requirements, and allow a higher debt-to-income ratio. FHA mortgage interest rates are often slightly lower than a similar conventional mortgage, but the total monthly payment is often slightly higher because of the mortgage insurance costs.
Mortgage insurance is required when the down payment is less than 20%. The premium cannot be waived in the future if the amount borrowed was over 90% of the value of the property purchased (LTV). If the LTV is under 90%, the mortgage insurance premium is removed after 11 years.
Loans backed by the Veterans’ Administration are designed as a benefit for military service members and veterans. VA mortgages allow 0% down and require a funding fee rather than mortgage insurance. They have forgiving credit score requirements and allow larger debt-to-income ratios.
ARM vs. Fixed-Rate Mortgages
Adjustable-rate mortgages or ARMs have introductory interest rates that are below market. The initial rate expires after a set period of time, anywhere from 1 to 15 years. The interest rate is then reset to reflect current market rates according to an assigned index, such as LIBOR.
ARMs can be popular when interest rates are trending high, as the initial rate is significantly lower than market. However, the future rate could be higher than what the current market would provide on a fixed-rate mortgage.
ARMs are best suited for home buyers who plan to sell within a few years or who have the financial ability to withstand the risk of higher mortgage payments.
Fixed-rate mortgages have no interest rate changes during the life of the loan.
Getting the Right Loan for You
A Realtor will advise you to shop for a loan until you find the right mortgage for you. Here are some questions that will help you determine which lender and loan is best for you.
- Which type of loan is best for me?
- What is my interest rate and annual percentage rate?
- Will there be origination fees?
- What are ALL the costs?
- Can I lock into a rate?
- Are there any penalties for pre-payment?
- Will you guarantee GFE (good faith estimate)?
- How much time do you need to fund my loan?
- What is a yield spread premium?
- Do you handle your own underwriting?