A home might be the largest purchase you will make in your lifetime. Hence, you are unlikely to buy a home with only the cash you have on hand – this is where a mortgage comes in. When considering a mortgage, it is important to calculate the overall expenses, including taxes and other fees, in much the same way you'd manage your business finances or credit card payments.

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Of all the home loans available on the market, conventional mortgages are the most popular. In this guide, we will discuss conventional loan mortgages in-depth! We will define what conventional loan mortgages are, compare them to different mortgage types, and share tips on how to save on your mortgage. 

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To help plan for your home purchase, we also provide tools like a calculator to estimate your recommended loan amount and payments. Additionally, we will cover the various products and options available as well as informative and useful content for you to understand the mortgage process better.

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What Are Conventional Mortgages? 

Home loans not sponsored or backed by the federal government are considered conventional loans. Lenders provide these loans to creditworthy borrowers. These lenders range from banks and credit unions to mortgage brokers and companies, with their products catering to a wide variety of consumers and their unique needs.

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Conventional loans adhere to conforming loan limits set by the Federal Housing Finance Administration (FHFA). These loans are also subject to the requirements set by Fannie Mae and Freddie Mac, two government-sponsored companies that guarantee mortgages.

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Unlike government-backed loans, conventional loan borrowers are not financially protected if they fail to repay. The lenders also do not receive a federal guarantee if the borrower defaults on the loan, so lenders often apply stricter requirements to prospective borrowers.

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However, conventional loans are free of requirements that may be imposed by government loans, such as being a service member to qualify for a VA loan. Anyone can qualify for a conventional loan if the borrower meets the credit score and debt-to-income ratio standards the lender sets.

Most Common Conventional Mortgage Types 

Research in the home buying process has shown that various loan options are available to accommodate different buyers' needs and financial situations. Taking account of your financial stability, bank statements, and savings accounts can help you determine the loan that suits you best.

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In the section below, we will discuss the two significant conventional mortgage loans. They also have different benefits and caveats – we break those down in the section below.

What Is a Fixed-Rate Mortgage?

Fixed-rate mortgages are the most popular for first-time homebuyers in the United States. True to its name, the interest rate and APR stays the same throughout the life of your loan. The monthly principal and interest payments will also remain the same.

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These loans are amortizing, which means that by the time the loan ends, you’ll have paid for everything you owe – both the principal and the loan's interest. The early payments pay the interest, while payments you make later pay the loan principal.

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Lenders offer varying terms of fixed-rate loans. Often, people opt for a 30-year fixed rate, the longest term most lenders provide. However, you can also opt for a 15-year loan. Besides 15-year and 30-year fixed loans, lenders also offer 10-year and 20-year terms.

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Fixed-Rate Pros:

• Stable Interest Rate And APR: The main strength of a fixed-rate mortgage is its stable interest and APR. Once you qualify for a specific rate, it won’t increase or decrease throughout the life of the loan. Locking a loan during a time of low-interest rates will save a lot of money on interest payments.
• Payment Stays Constant: Fixed-rate loans are easier to predict in the long term because the payment amount stays the same for the life of the loan. This stability allows borrowers to budget and plan their finances more effectively, making the fixed-rate mortgage a preferred choice for many. This predictability allows you to budget around your monthly mortgage. Many financial services have dedicated sections on their site for answering questions about mortgages and providing tools to help you calculate your potential savings.

Fixed-Rate Cons:

• Higher Interest Rate And APR: The static interest rate on a fixed mortgage comes with a significant drawback: lenders charge higher interest rates than an ARM's introductory rates. If you qualify for a loan during a period of high mortgage rates, you’ll pay more for the entire loan term. This is closely tied to the federal reserve's policies in place and its impact on interest rates.
• Few Options for Reducing Your Interest Rates: Another weakness of fixed interest rates is that they cannot be changed once you qualify. However, you can work around this by applying for a refinance. When you refinance loans, the current mortgage is replaced with a new one with a lower interest rate. For more details and helpful FAQs, be sure to visit your lender's site.

What Is an Adjustable-Rate Mortgage?

The second primary loan is an adjustable-rate mortgage (ARM). These loans are more complicated than fixed mortgages because their rates will change. Most ARMs have an introductory period featuring fixed interest rates before the adjustable phase starts.

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The length of an ARM’s introductory period and adjustment frequency is expressed in its title. For instance, a 5/1 ARM means you will have five years of fixed interest rates. Once the five years have passed, the loan’s interest rate will be adjusted annually.

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To prevent mortgage rates from fluctuating, lenders apply caps on the ARM. These caps limit the variable on the interest rate and how much you pay per month.

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Adjustable-Rate Pros

• More Affordable Initial Rates: An ARM features competitive rates in its introductory fixed-rate period. Applying for a 5/1 ARM will give you five years of predictable and affordable payments. Take advantage of the low interest to prepare for the less-predictable period of adjustable rates afterward. This is a good opportunity to place your savings in a high-yield account or make additional investments.
• Chance To Get Lower Rates: Because an ARM’s rate depends on an index, you may experience lower interest rates if the index is driven down. If your rates are adjusted to be lower, you’ll also be charged less on your monthly payment until the rate readjusts next year.

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Adjustable-Rate Cons

• Interest Rates May Increase: The mortgage rate may increase if the index moves up. While caps may stop rates from rising to unaffordable levels, you’ll still pay more expensive monthly installments. Without proper budgeting, this may land you in a financial bind.
• Risk Of Negative Amortization: While caps are meant to protect you from paying too much, they pose a threat. If the mortgage rate increase causes the monthly payment value to exceed the cap, you may be paying less than you should. By paying less than what you owe, you’ll experience negative amortization, which means the loan balance will increase.

What Type Of Conventional Mortgage Is Best For Me? 

Different plans require various mortgages. In this section, we’ll break down three standard mortgage options and the circumstances in which they’ll work best.

30-Year Fixed-Rate Mortgages

A 30-year fixed-rate mortgage is best if you’re looking to find the cheapest monthly payments. You’ll get the best value out of a 30-year fixed-rate loan if you plan to stay in the house long-term, especially if you have locked in low rates when you qualify for the loan.

15-Year Fixed-Rate Mortgages

A 15-year fixed-rate loan also features consistent monthly payments. However, you’ll pay higher monthly installments. Lenders also impose lower rates on a 15-year loan.

Adjustable-Rate Mortgages

Because of an ARM’s volatility, these loans are best used if you want to stay in the house for a short term. You can enjoy the cheaper rates during the introductory period and then sell the property or refinance the loan before the rates start to adjust.

Interest Rate vs. Annual Percentage Rate: Knowing The Difference

When shopping for a mortgage, you may be offered information regarding the loan’s interest rate and annual percentage rate (APR). While these two may seem the same, there are some key differences.

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An interest rate represents the cost of borrowing the principal loan amount, often expressed as a percentage. The APR, however, represents the broader cost of the mortgage. This rate considers the loan’s interest alongside other associated costs, including your loan origination fee, lender fees, closing costs, and discount points. All these factors can significantly affect your decision when choosing a mortgage product.

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Lenders should disclose both mortgage rates to ensure the borrower knows what they’re paying before they submit the mortgage application. You can use both interest and APR to compare loan offers as a borrower. This way, you can make informed decisions when selecting the best mortgage option for your needs.

Factors Affecting Conventional Mortgage Interest Rates

There are numerous and varied aspects that determine one's mortgage rates, which can have a significant impact on the amount of interest you will pay on your loan. See below for information on the most important factors. 

• Credit Score: an important factor in determining how much you can borrow and the interest rate you will pay. A good credit score will help you get a lower interest rate and save money in the long run. 
• Down Payment: the amount of money you are able to put down upfront when you purchase a home. The larger the down payment, the less you will need to borrow and the lower your monthly payments will be. This is because the more money you can put down upfront, the less you will need to finance. 
• Debt-to-Income ratio: another key factor in determining whether you will be approved for a loan, and it is also important for lenders to assess your ability to repay the loan. This ratio is calculated by dividing your total monthly debt payments by your gross monthly income. It is an important factor for lenders to consider when determining your creditworthiness. 
• Loan-to-Value Ratio: a comparison between the amount of money you are borrowing and the value of the asset you are using as collateral. It is calculated by dividing the amount of the loan by the appraised value of the asset. This ratio is used to measure the risk associated with the loan. The lower the ratio, the less risky the loan is considered to be. 
• Loan Details: When applying, the loan type, term, and amount are important facets to consider when making a decision. If you are looking for a loan with a lower interest rate, you will want to look for a secured loan with a shorter term. A secured loan is one that requires collateral, such as a car, boat, or house, to be used as a guarantee that the loan will be repaid. 
• Property Details: The house's construction type, location, and price may also play a role in deciding mortgage rates. If you are shopping for a home in a competitive area, interest rates and prices will reflect that in higher figures than in more remote locations. 

How to Calculate Conventional Mortgage Interest Rates

Calculating the cost of a conventional mortgage can be a complex process, especially for those who are unfamiliar with the terminology and calculations involved. The interest rate is a crucial factor in determining the cost of a mortgage, and it can be affected by a variety of external influences. 

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One's monthly mortgage payments can see drastic changes by just minimal differences of a decimal in their interest rate. To see the difference, utilize our online mortgage calculator to get an estimate of your own monthly payments and amortization schedule.

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Strategies to Negotiate Conventional Mortgage Interest Rates

After obtaining pre-approval for a home loan, it may be tempting to quickly move toward the purchasing phase. However, potential homebuyers should take the time to negotiate the loan's rate of interest - as this can save a significant amount of money across the lifetime of the loan due to the effect the rate has on monthly payments and total closing costs. 

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Here are a few tips on how to bargain for the best mortgage rate with lenders:

• Check your credit reports beforehand so as to know where you stand
• Research all mortgage options to know which loan terms best fit your circumstances
• Obtain quotes from multiple different lenders to better position yourself for negotiations
• Compare loan estimates, including interest rates and total loan costs
• Negotiate with your lender for better rates and terms by showing them offers from competitors

Should You Lock In Your Mortgage Rate?

Locking in your mortgage interest rates means that you are committing to a certain interest rate for a set period of time, usually 30 days. This can be a great way to protect yourself from any sudden rate hikes and can help you to budget more effectively. 

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However, it is important to remember that locking your rates does not always guarantee that you will save money. In fact, if market rates drop, you may end up paying more than if you had not locked in your rate. Therefore, it is important to do your research and look into the current market trends before deciding to lock in your interest rate. 

Comparison of Conventional Mortgage Interest Rates to Other Types of Mortgages

Conventional mortgages are the most common type of mortgage and often have the lowest interest rates. However, there are other types of mortgages available that may provide more attractive interest rates for those who qualify. While conventional loans may be the most popular form of home financing, there are several government-backed options to consider. These loans feature more affordable rates, lower credit score requirements, and lower down payments.

FHA Loans

These loans are insured by the Federal Housing Administration and are aimed at low-income borrowers with bad credit scores. FHA loans require a lower down payment and credit score requirement than a conventional loan. To qualify, a homebuyer with a credit score of 580 and above can provide as little as a 3.5% down payment. Borrowers can use funds from their savings accounts or equity from other sources for the down payment.

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‍Because the FHA insures these mortgages, FHA-approved lenders can only issue them. Borrowers must also pay mortgage insurance to protect the lenders in case the borrower fails to make their payments.

VA Loans

Administered by the Department of Veteran Affairs, these loans are provided to current and former service members as well as their spouses. Because the government protects lenders if the homebuyer defaults, lenders offer more favorable terms and waive the down payment.

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Many lenders offer VA loans. These loans have a stricter standard for property safety, and they’re only available when buying a primary residence. The low down payment requirement is also balanced by the funding fee, which replaces private mortgage insurance (PMI) and protects lenders if you fail to make payments.

USDA Loans

Another government-backed option to consider is a USDA loan. This loan type is supported by the Department of Agriculture and is geared toward homebuyers who want to find real estate in suburban regions. With no down payment and low interest, use these loans to buy a new home or pay for home improvements.

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Because this type of loan is meant for individuals who cannot otherwise qualify for a home loan, USDA loans are provided to people who do not have safe and sanitary housing, as well as those living below the median income in their area.

Tips on Saving Money On Your Mortgage 

Because mortgages are a long-term commitment, saving as much as possible is prudent. Here, we provide three tips to save money on a home loan.

Pay a Larger Down Payment

While most mortgages require 20% or less in some cases, you can still pay more than the required minimum. You can reduce your loan-to-value ratio by paying a higher down payment, which means your monthly payments and interest will be lower.

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In addition to lowering your rates, you’ll avoid the mortgage insurance requirement. Because mortgage insurance protects the lender if you default on your loan, it’s best to avoid paying the cost, if possible.

Compare Loan Offers From Mortgage Lenders

Lenders must provide standardized documents containing their loans' interest rate and annual percentage rate (APR). However, there are other factors to consider. Pay attention to the closing costs the lender sets and prepayment penalties if you refinance your loan before its term ends.

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Consider Refinancing

Refinancing your loan entails taking out a new mortgage to pay off the existing one. Depending on your mortgage type, you’ll benefit from a refinance differently.

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With a fixed mortgage, you can refinance if the market rates drop and you want to take advantage of it. If you have an ARM, you can refinance at the end of the introductory fixed-interest period and wish to switch to a fixed-rate mortgage.

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Closing Thoughts 

Conventional loans are popular because borrowers can choose either to meet their needs. Both fixed-rate and adjustable-rate loans can help you save money on a mortgage. You can also consider refinancing and paying a larger down payment.

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For the best-valued conventional loan, Wesley Mortgage is here to help! We understand that making decisions about your finances can be a difficult and daunting task. That's why we strive to provide you with the most comprehensive and up-to-date information available. 

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We have a team of experienced loan officers who will take the time to understand your individual needs and financial situation. We will provide you with a comprehensive overview of the different types of conventional loan options available and help you determine which one is best suited for you. Our loan experts are here to provide you with the information you need to make the best decision for your financial situation. 

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