If you’ve been fantasizing about becoming a homeowner, it’s important to know the differences between the various kinds of mortgage loans currently available to borrowers. Picking the right loan for you depends largely on your specific financial status, as well as other factors.
In other words, before you start touring Charlotte houses for sale, you might want to brush up on the pros and cons of each kind of loan using the information below.
In general, mortgage loans can be divided into two groups: conventional and unconventional. A conventional mortgage is any home loan that conforms to the underlining guidelines required by Fannie Mae, one of the two major mortgage companies in the U.S., alongside Freddie Mac.
Though Fannie Mae and Freddie Mac are federally backed, that doesn’t mean that conventional loans are also federally backed.
Rather, Fannie Mae and Freddie Mac purchase mortgages from lenders on the secondary mortgage market.
This is in turn provides stability and liquidity to lenders, allowing them to continue offering mortgage loans to borrowers like yourself.
The guidelines that conventional loans have to adhere to include such things as the borrower’s credit score (which must be at least 620), debt-to-income ratio (which typically can’t exceed 45%), down payment amount (which must be at least 3% of the total loan).
If your down payment is less than 20% of the total loan amount, a conventional loan will also require you to pay for private mortgage insurance to protect your lender in the event you default.
Despite these strict requirements, conventional loans are popular with many homeowners because, after accounting for interest and fees, conventional loans often cost less than unconventional ones.
In contrast to conventional mortgages, unconventional mortgages include any loans that do not conform to Fannie Mae’s strict guidelines. These include both subprime mortgages and a variety of government-insured mortgages.
Subprime mortgages are mortgage loans that lenders offer to prospective homeowners who don’t meet the requirements for conventional loans, such as those who have poor credit scores, significant debt, or little in the way of savings.
This allows individuals who are experiencing hard times the opportunity to obtain housing despite temporary setbacks.
The downside to subprime mortgages is that lenders often impose harsher terms in order to help recoup their investment. These terms may include higher interest rates, prepayment penalties, and more.
Government-insured mortgages, meanwhile, are loans wherein the government agrees to pay the remainder of what a borrower owes should their lender foreclose on the property due to delinquent payments.
The three types of government-insured mortgages available are VA loans (available to veterans of the U.S. armed forces), USDA loans (available to borrowers who agree to live in specific rural areas), and FHA loans (available to borrowers who aren’t eligible for other kinds of loans and who agree to pay an annual mortgage insurance premium).
If you meet the requirements to receive a government-insured loan, you may wish to consider applying.
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However, it’s worth reiterating that for most borrowers, conventional loans actually cost significantly less in the long run, especially in comparison to subprime mortgages.