Conventional real estate purchases are made using conventional or traditional loans. Conventional or traditional loans are those loans that are not guaranteed or insured by the federal government unlike FHA and VA loans. Conventional loans are secured by investors. A conventional loan lender may choose to maintain the loan in their own portfolio or sell the loan to the secondary market. Conventional loans are considered conforming loans because they follow the terms and conditions set forth by Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac guidelines establish things such as maximum loan amounts, down payment, and income requirements.
Types of Conventional Loans: Fixed Rate and ARMs
Fixed rate mortgages and adjustable mortgages are two types of conforming, conventional loans. Fixed rate mortgages are one of the most commonly used types of conventional loans. Fixed rate mortgages are available from 10 year to 40 year loan terms. However, the most popular loan terms are 15 and 30 years. The longer the term of the loan, the lower the monthly payments and the more interest will be paid over the life of the loan. With a 15 year fixed rate mortgage, monthly payments will be higher but the the loan will be paid twice as fast as a 30 year fixed rate mortgage. Therefore, with a 15 year fixed rate mortgage, significantly less interest will be paid at the end of the loan term than with a 30 year fixed rate mortgage. Fixed rate mortgages are popular because interest rates will not change over the life of the loan. The borrower will “lock into” an interest rate at the beginning of the loan, and that interest rate will remain the same.
The defining characteristic of adjustable rate mortgages (ARMs) are their variable interest rates. This may be one reason ARMs are not utilized as often as fixed rate mortgages. During the life of the ARM, the interest rate will fluctuate based on a defined index. This index will be established at the beginning of the loan. The changes in the loans interest rate will affect the borrower's monthly payments. ARMs do provide borrower some protection from unreasonable interest rates as most ARMs have an interest rate cap. This cap is designed to protect borrowers from unprecedented rises in monthly payments. AMRs have a lifetime cap limit and a periodic cap limit. The lifetime cap limits how much the interest rate is increased over the life of the loan while the periodic cap limits the amount an interest rate can rise at one time. ARMs are available in 15 to 40 years terms, with 30 year terms being the most common. In the beginning, these types of loans generally have lower interest rates than fixed rate mortgages.
Other Types of Conventional Loans
Other types of conventional loans include things such as option ARM loans and combined or hybrid loans. Hybrid loans include things such as fixed-period ARMs, convertible ARMs, and graduated payment mortgages.
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