Becoming a homeowner is one of the most exciting, rewarding, and overwhelming processes we work through as adults. We spend hours looking through listings until we come across the one, the house that makes us feel like we have come home. I get it. I’ve been through the home buying process myself, and I have walked my clients through it time and time again as a realtor. Touring houses is the fun part of the process, and just as there are different styles and sizes of homes to suit your taste, there are also a variety of ways to finance them.
The financial component of the real estate transaction is where many buyers start to feel stressed and sometimes a bit scared. I want you to know that you don’t have to feel that way! There are extremely capable professionals who will walk you through the mortgage process and ensure you get the best loan option for your particular situation.
However, just because there are others to hold your hand through the process, doesn’t mean you shouldn’t educate yourself. I am a firm believer in learning as much as possible about everything concerning your home, especially your mortgage, so today I am sharing part one of a series of blogs on the most common types of mortgage loans.
I want you to know enough about each of these loan options to be able to talk through your choices with your financial officer, which will help you feel confident in making this major investment. The first type of mortgage I want to talk about is the Conventional Loan, which is still the most common type of financing we see in real estate. In basic terms, a Conventional Loan is simply a loan that is not guaranteed or secured by the government. Community banks can continue approving buyers for 15 or 30 year loans without the fear of running out of money because bigger entities will buy them. These Conventional Loans are bought by Freddie Mac and Fannie Mae from the smaller banks to ensure liquidity in the lending world. This is a good thing for buyers because they can rely on individual, local service on from their banks, while the financial giants maintain the money flow.
The Conventional Loan has a few variations within the category. Each of these types of loan can be borrowed on a 5 – 30 year term. The longer the term on the loan, the lower the monthly payments will be, but that also means more money will be paid toward interest.
The Conventional Fixed-Rate Loan is often chosen because it is predictable. Its interest rates and terms are locked in for the life of the loan, and because of this it is easy to “shop around,” talking to different lenders to get the most competitive rates. Many people like this option because it is straightforward and provides peace of mind since it will not change. This is a good option for buyers who plan to have a long-term loan and have money available to make a 5-20% down payment. The only drawback on this type of loan is bad timing. If you lock in your interest rate, only to find out they drop significantly a year or two later, you might kick yourself for not waiting to buy. However, the market is always unpredictable and paying a little extra each month for peace of mind might be worthwhile to you.
Another option within the conventional category is the Conventional Adjustable-Rate Loan. The ARL is a tempting option for many buyers. These loans typically offer an introductory period with a low, fixed rate, and after that time period (usually 2-5 years), the rate begins to increase and can fluctuate annually depending on the market. If rates do go down, sometimes your payments still will not because of high interest payments. There are often pre-payment penalties on these loans as well, meaning you cannot just pay off the loan or refinance to avoid these higher rates unless you pay a hefty fee. However, these ARL loans might work for some. If you are able to pay off the entire loan in the short introductory term, the low rates would be appealing to you. Lenders are legally required to give borrowers all of the terms of their mortgages, so if you committed to an ARL, you would be able to plan ahead and aggressively pay off your mortgage.
If you’re considering applying for a Conventional Loan, I want you to remember one more phrase – private mortgage insurance. If you do not have a 20% down payment relative to the value of the home you plan to buy, you will be required to have PMI included in your monthly mortgage payments. This is a tool banks use to protect themselves against the risk of borrowers defaulting on their loans. When you pay down your mortgage and reach that 20% in equity, you need to reach out to your loan officer and make sure your PMI is removed. I can tell you from personal experience that the bank does not always do this automatically – take charge and make sure you’re not continuing to give your money away!
I hope this information has given you a more clear understanding of the background and options within the Conventional Loan. It is a great option to finance your new home, but it is not the best option for everyone. Stay tuned for my next post in the series, because I’m going to share another mortgage option that just might be the right fit for you!