Conventional (Conforming)
Conventional loans make up the majority of loans written to borrowers and are either conforming or non-conforming. Conforming loans are securitized by government sponsored entities like Fannie Mae and Freddie Mac, bundled into huge pools of mortgages called CDO's (Collateralized Debt Obligations) and then resold to investors all over the world. These loans typically offer the best interest rates available and are reserved for borrowers with good credit and low risk - called "prime borrowers." The interest rates on conforming loans loosely follow the 10 year treasury bonds for fixed loans, with ARM rates a bit lower.
Conventional loans can be used for purchase money or refinances. There are some excellent conforming programs for first time home buyers such as Fannie Mae's "My Community" and Freddie Mac's "Home Opportunities." These loans are similar to FHA loans. Single family dwellings, multi unit properties up to 4 units, condos, town homes and some manufactured homes are eligible for this type of financing. They come in all types of products including: Fixed Rate (FRMs), Adjustable Rate (ARMs), Interest Only, Graduated Payment Mortgages, and Jumbos. Terms include the standard 30 year, 20 and 15 year, but also can extend out to 40 years.
Most conforming loans require that borrowers be able to prove their income (Full Document), however a smaller percentage of these loans can be made to Stated income borrowers under the right circumstances. Stated income usually refers to self-employed borrowers who make a certain amount of money, but claim a much smaller amount of adjusted gross income to the government because of tax deductions. They can also be for borrowers who make a certain income, but are unable to prove it this income in traditional ways. Stated income loans are inherently more risky for the investors who buy the mortgages, therefore, stated income loans usually have more restrictive financing terms and require higher credit scores.
Conforming loans prefer borrowers who have assets or enough savings to pay their new mortgage for at least six months. This attribute lowers risk because borrowers with a safety net are less likely to default. Borrowers with one or more late payments on their current mortgage or rent will find it very difficult to obtain financing for a conforming loan with a low rate. And any bankruptcies need to have been discharged for at least 4 years before applying for a conforming loan.
Conforming loans usually do not include a pre-payment penalty, and they do mandate mortgage insurance if the financing exceeds 80% of the home's value.
Loan limits for conforming mortgages are always in a state of flux and depend on the market. High cost areas like big cities will typically have a higher loan limit than areas not as populous. However, it's a good idea to check the conforming loan limit in your area if you are trying to obtain approval for a conforming loan. Currently, the maximum loan limits for the continental US is $ 729,750 for certain metropolitan areas such as Washington, D.C., Los Angeles, San Francisco, New York City, Salt Lake City and $793,750 for Honolulu, Hawaii. Jumbo mortgages are mortgages that exceed the loan limit in your area.
Jumbo Loans
Jumbo mortgages are loans that exceed the conforming loan limits set by Fannie Mae and Freddie Mac. Jumbo loans can be obtained from conforming lenders who sell the jumbos to private investors or through Portfolio Lenders who lend their own money from deposits (usually banks or insurance companies). Some lenders even specialize in jumbo loans. Interest rates for Jumbo Mortgages are always higher because of the additional risk. In the event of a default, it is harder to sell a property linked to a jumbo mortgage because there is a smaller market of eligible borrowers.
As such, jumbo loans typically have higher credit and asset requirements, as they are a bigger risk to the lender/investor. And they usually require a more of a down payment for a purchase. Lenders usually require two appraisals due to greater variance in value. These types of home values will fluctuate more during a volatile market. A loan in excess of $650,000 is referred to as a super jumbo mortgage.
Subprime Loans (Non-conforming)
Subprime loans came into existence in the early 1990's to fill a need for higher risk borrowers. Before the 1990's, it was difficult for people with impaired credit to obtain mortgage financing. Many people with bad credit are good people who've had bad things happen to them - such as job loss, illness that can lead to late payments, bankruptcy or foreclosure. Subprime mortgage companies opened the door to a credit impaired population who needed financing and could not find it through traditional loans.
Subprime companies were willing to make loans to higher risk borrowers for a higher cost. That higher cost takes the form of higher rates and usually higher closing costs.
Lenders of subprime mortgages evaluate the borrowers risk level - the higher the risk, the higher the interest rate to justify the additional risk the lender takes. Higher risk borrowers most certainly have higher default rates, as is evidenced by the subprime melt down of 2008. The vast majority of foreclosures were and are still attributed to subprime borrowers.
Subprime loans can be a good short term option while borrowers work to improve their credit and perhaps consolidate debt. After improving your credit score, its usually best to refinance into a better conforming type of loan with a lower interest rate. Subprime rates are significantly higher, but they usually don't involve any mortgage insurance. Subprime loans do however almost always have pre-payment penalties something the conforming loans don't require.
