If you’re in the market for financing your home, there are several different types of conventional loans you can choose from. In fact, taking out a loan could be a smart financial move even if you don’t need it.
With mortgage rates as low as they are, you might come out ahead by hanging onto your cash and investing it instead. And, depending on how you file your taxes, you might even be able to write off the mortgage interest you pay on your loan — making the money you earn on investment all profit.
There are several different types of conventional loans to choose from, though, so it’s important to understand which one is best for your situation. Otherwise, you may end up with a loan that doesn’t fit your needs.
What is a conventional loan?
Conventional loans are loans that are not insured or backed by any government entity, so lenders consider these higher risks than VA or FHA loans, which are guaranteed by different federal government departments.
With a conventional loan, you’ll have to prove to the lender your ability to repay the mortgage loan by providing documents like pay stubs, tax returns and bank statements. Lenders will also want to check your credit history to see if you pay your bills on time, and will also require an appraisal to determine the value of the home you want to buy. Without meeting these requirements, you may find it difficult to be approved for a conventional loan.
If you do qualify though, conventional loans can offer more flexibility in the form of low interest rates, lower fees and a larger variety of loan programs.
Types of conventional loans
Fixed-rate conventional loans
With a fixed-rate conventional loan, the interest rate you pay remains the same for the entire life of the loan. That means your monthly payments will stay the same, too. With mortgage interest rates as low as they are right now, it’s a great time to lock in a low interest rate for the entire life of your loan.
Adjustable-rate conventional loans
Compared to fixed-rate mortgages, adjustable-rate mortgages (commonly called ARMs) usually offer a lower introductory interest rate, but that fixed rate only lasts for a short time frame. Once the period of fixed interest is over, ARM loan rates adjust on an annual basis based on a number of factors.
For example, ARMs can offer a fixed interest rate for the first five, seven or 10 years, after which it could change on an annual basis. Many ARMs also have terms indicating the absolute highest or lowest the interest rate can ever be — and most ARM loans also have a cap on how much the rate can increase per year.
Conforming conventional loans
If your loan amount falls within the maximum loan limits set by the Federal Housing Finance Agency, it will be considered a conforming loan. These limits vary based on where your home is located, as well as the property type. These maximums can be adjusted from one year to the next, and areas with a higher cost of living will typically have higher loan limits.
Non-conforming conventional loans
Loans that exceed the maximum loan limits set by the Federal Housing Finance Agency are considered non-conforming loans — or jumbo loans. Since the amount borrowed with a jumbo loan is typically much higher, lenders view these loans as higher risk. To balance out some of that risk, approval and documentation requirements can be quite strict for these loans.
Homes that require repairs or renovations may require a renovation loan. These types of loans — also called 203(k) rehab loans — usually include additional financing for repairs or upgrades to be made to the home. Lenders expect some of the funds to be used to improve the property, so there is a lot more flexibility when it comes to conducting an appraisal to determine whether the condition of the home is acceptable.
Low down payment conventional loans
Many conventional loans require between 10% and 20% down payment. However, if you don’t have that amount saved, or prefer to put a smaller down payment on a home, low down payment conventional loans can allow you to come in with as little as 5% or 3%. Conventional loans that only require 5% down are often referred to as 5 down conventional loans. Some lenders may also offer 0% down payment loans.
How to know which loan type is right for you
Fixed-rate versus adjustable-rate
If you are deciding between a fixed-rate conventional loan and an adjustable-rate conventional loan, you should think about how long you will be in the home. If you plan on staying in the home for a long time, it may make more sense to choose a fixed-rate mortgage so that you have the peace of mind of knowing that your monthly payment will not change.
On the other hand, if you plan on selling the home in a few years, it may make more sense to choose an adjustable-rate mortgage so that you can take advantage of a lower interest rate for the short-term. You just need to be sure that you’ll sell it before the rates adjust or you could end up paying a lot more in interest.
[ Read: Current ARM Mortgage Rates ]
Conforming versus non-conforming
You won’t have any control over what the FHFA determines each county’s conforming loan limit to be, but you do have some control over the loan amount you choose. Lenders look at non-conforming loans as higher risk because of the larger loan amounts, so if you have the extra cash and can take a conforming loan, you could see some savings in the form of lower interest rates and fees.
A renovation loan can be helpful if you need funds to complete any repairs or renovations. It can also be a more efficient use of your time and money, since it can save you the hassle of having to apply for a separate loan.
Low down payment
If you want to become a homeowner but don’t have much cash saved for a down payment, low down payment conventional loans could be your ticket. This can also be a good loan to consider if you’re just looking to hold onto as much cash as possible. Low down payment conventional loans, such as a HomeReady loan, can require as little as 3% down. Some credit unions or local banks may also offer 0% down payment loans.
Tips on shopping for a loan
It’s important to know how to find the best mortgage rates with a reputable lender. Here are some things to keep in mind when shopping for a loan:
- Research lenders as much as possible. Online reviews are a good place to see what other borrower’s experiences have been with a lender. You can read up on how quickly the lender processes applications, whether its employees were helpful and knowledgeable, and how quickly they respond to questions. You should also ask around to see what lenders trusted friends or family members prefer.
- Look at multiple rate quotes. Some sites make it easy to compare multiple lenders all in one place, or you can just shop lenders one by one. Lenders know they’re competing against each other for your business, so this can be a valuable resource for finding great rates. Whatever you do, make sure you get as many rate quotes as possible so you can choose wisely. You can shop for lenders for a 45-day window and it will only count as one hard credit pull, so make sure you do any hard pulls during that window.
- Check with your local credit union. Credit unions don’t often pay to advertise their interest rates on other websites, but they’re known to have some of the lowest rates around. Credit unions are not-for-profit organizations, which means they can pass on the savings to you in the form of lower interest rates and fees. Don’t ignore them for the bigger lenders.
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