One of the most common forms of mortgage is the conventional mortgage. There are many ways that a person can obtain the mortgage loan needed to get into the home of their dreams. This is a great thing, but it does leave people confused about what the terms and conditions are when they choose a certain type of mortgage. In this article, we’ll detail the basics of conventional mortgages in hopes of providing you with some clarity and confidence as you move down the path toward homeownership.
What is a Conventional Mortgage, Anyway?
To keep it simple: A conventional mortgage loan amounts to no more than 80% of the home’s appraised value. This means that the borrower must have a minimum of a 20% down payment that they can spend, aside from the value of their loan.
For example, if you were to buy a home valued at $200,000, you would be on the hook for a $40,000 down payment if you desire a conventional mortgage loan.
This differs from a high-ratio mortgage, wherein the borrower offers less than the 20% down payment required to obtain a conventional mortgage. Under a high-ratio mortgage, borrowers must also pay for mortgage insurance. This protects the lender in the event that the prospective homeowner defaults on their debt.
A down payment cannot be paid with borrowed money, such as money obtained from a personal loan.
Why Should You Consider a Conventional Mortgage?
A 20% down payment sure sounds steep, and it might very well be, but homeowners find that there are many benefits to being able to meet this requirement.
You Stand to Pay Less in Interest
Generally speaking, you can expect to pay lower interest rates on a conventional mortgage. This is because the rule of thumb is that a higher down payment equals less interest to pay. Paying less in interest allows you to put more of your monthly payments toward the principal of the loan. You might even be able to pay it off quicker than expected if you aren’t crushed under the weight of high interest rates!
You Don’t Have to Buy Mortgage Insurance
Mortgage insurance doesn’t help the borrower, but rather the lender. In a high-ratio mortgage situation, home buyers must pay an additional monthly cost for mortgage insurance if they cannot facilitate a down payment of at least 20%. This type of insurance protects the lender in the event that the borrower cannot pay back their debt in the agreed-upon fashion.
You Get Faster Access to Your Home’s Equity
That 20% paid via your down payment immediately opens a greater line of equity that you can choose to borrow from at a later time. If you pay less than 20%, this minimizes how much equity you’ve got accessible to you. Depending on the lender, those who get conventional mortgage loans may have numerous options of tapping into their home’s equity – such as a Home Equity Line of Credit (or HELOC).
Conventional mortgage loans, just like any other type of loan, are more complicated in reality than they may seem on paper. Before you dive in and throw your down payment toward the purchase of a home, it doesn’t hurt to have a professional real estate attorney or mortgage broker assess your circumstances and help you decide whether this is really the best financial move for you to make.
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