What are Conventional Loan Programs?
Conventional loan programs by definition are any mortgage which is not guaranteed or insured by the federal government. This type of loan was the first traditional mortgage loan made by local banks. The loans were held by the bank in a portfolio until paid in full. There are a number of advantages to conventional loan programs, there are also some disadvantages. Conventional loan programs generally require a larger down payment and have stricter debt to income ratio requirements. Conventional loan programs do not have an up front mortgage insurance premium due, but may have monthly private mortgage insurance if certain loan to value ratios are exceeded.
Fannie Mae and Freddie Mac purchase mortgages that conform to conventional loans limits, down payment requirements, debt to income ratios and other established underwriting guidelines. Both Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) are government sponsored enterprises created by congress to purchase conforming mortgage loans and resell them on the secondary market.
Conventional loan programs are loans where real property like a fixed building or home is provided as collateral or security whose equity is reserved to be delivered to the lender in case the borrower defaults on repayment of the debt. This is generally formalized in a mortgage note which documents the encumbrance of the fixed asset in exchange for the funds required to purchase the property. A home buyer can get conventional loan programs from a bank or mortgage lender or through intermediaries like a mortgage broker who will connect the borrower with a lender.
What are the Basics of Conventional Loan Programs?
Conventional loan programs are defined by the basic tenets of:
- Principal - The total amount that is borrowed less any down payment funds.
- Interest - The additional amount paid per month in addition to any principal payment that is amortized over the life of the loan.
- Term - The number of months that payments will be made until the principal is repaid and the interest on the loan is satisfied.
- Payment - The combination of a portion of the principal, interest, and any fees, insurance or other charges that are due in that month.
- Down Payment - The initial payment paid against the total loan amount that is deducted before the principal borrowed amount is calculated.
There are different ways that interest is applied to conventional loan programs including:
- Fixed Rate Conventional Loan Programs - A mortgage loan where the periodic payment remains fixed for the life (or term) of the loan due to an unchanging annualized interest rate. Most fixed rate mortgages have a 30 year term but there are many variations including the second most common, the 15 year fixed rate conventional loan programs. While the principal and interest may not vary in fixed rate conventional loan programs, other fees like property taxes and insurance premiums are likely to change over time.
- Adjustable Rate Conventional Loan Programs - This loan type can have a fixed rate of interest for the first three to five years but eventually will begin to vary based on a major market index (such as the Prime Rate, the London Interbank Offered Rate - LIBOR, or the Treasury index or T-Bill).
Paying Points on Conventional Loan Programs
Where a borrower's financial situation indicates a higher risk than the normal standards for conventional loan programs, the lender may increase the interest rate by one or more "points" which increases the overall profitability of the loan and offsets the higher risk that the lender is assuming by lending to the borrower.
Using a Balloon or Bullet Payment with Conventional Loan Programs
There is another type of amortization used in conventional loan programs where the number of payments are computed for a certain period of time (3 -5 years for example) but at the conclusion the balance of the outstanding principal is due for payment. This is referred to as a balloon payment or a bullet payment.
Conventional loan programs are the most baic form of lending with commonly accepted levels of risk and values that are considered reasonable safe to the lender or "conventional" in their risk level.