Loan Types | George Koutsos | Mortgage Consultant

Conventional Loans

A conventional loan is a loan that is not insured by the government; the lender takes on the risk of losing money in the event that the borrower defaults on the mortgage. Conventional loans may be either conforming or non-conforming. A conforming loan meets certain guidelines as set forth by Fannie Mae and Freddie Mac. The best-known of these guidelines is the size of the loan, the current maximum size being $417,000. Anything over $417,000 is non-conforming, or a jumbo loan. Jumbo loans carry more credit risk than conforming loans and therefore have slightly higher interest rates. Conventional mortgages come in a variety of terms and may have either a fixed or adjustable interest rate.

Government-Backed Loans

A government-backed loan is insured by the U.S. government. The government does not lend money to the borrower; instead, it promises to repay some or all of the money to the lender in the event that the borrower defaults. This reduces the risk for the lender when making a loan, making it possible to offer prospective borrowers lower interest rates. Government-backed loans can be a good option for borrowers who would not be able to qualify for a conventional loan. Compared to conventional loans, government-backed loans have lower down payment and credit score requirements. Their main purpose is to make home ownership affordable for low to moderate income borrowers who are unable to make a large down payment. Like conventional loans, government-backed mortgages come in a variety of terms and may have either a fixed or adjustable interest rate.

The two most popular types of government-backed loans are FHA loans and VA loans. FHA loans are very popular among first-time homebuyers, but are available to anyone who qualifies. They offer competitive rates, less-stringent credit requirements, and low down payments which can be as low as 3.5% of the purchase price. VA loans are available to eligible veterans and their spouses. They offer low down payments and favorable interest rates. VA loans offer up to 100% financing on the value of a home.

Fixed Rate Mortgages

A fixed rate mortgage is a mortgage loan where the interest rate and your principal and interest payment on the note remains the same throughout the term of the loan. Fixed rate mortgages come in a variety of terms, the most popular being 30 and 15 years. Generally, the longer the term, the lower your monthly payment will be, but with a higher interest rate. If you can afford higher monthly payments, a 15-year fixed rate mortgage allows you to repay your loan twice as fast and save more than half the total interest costs of a 30-year loan.

Adjustable Rate Mortgages

An adjustable rate mortgage is a mortgage loan where the interest rate and monthly payments adjust throughout the term of the loan. The rate periodically adjusts based on a defined index. The index for your particular loan is established at the time of application. Depending on the ARM program, the interest rate can adjust at various intervals such as once a year or every six months, for example. Most ARMs offer an initial lower interest rate than the fully indexed rate (index plus margin) during the initial period of the loan, which could be one month or a year or more. It is also known as a teaser rate. All ARMs are available with 30-year terms and some with 15- or 40-year terms. Adjustable rate mortgages typically have a lower initial interest rate than fixed rate loans.

The most popular type of ARM is the Hybrid ARM, which combines fixed rate and adjustable rate features. For example, the popular 5/1 ARM begins with a fixed interest rate for the first 5 years, but then changes to an adjustable rate mortgage with the interest rate changing once a year for the remaining term of the loan. It is important to note that if the interest rate does change, the monthly payment will also. Hybrid ARMs are popular with borrowers who are planning to sell their home within a certain number of years. An ARM with an initial fixed rate period that matches that time frame can save you thousands of dollars in interest payments. However, be aware that if you are unable to sell your home, you may be forced to refinance or deal with much higher monthly payments.