When the Conventional Mortgage Becomes Unconventional

When the Conventional Mortgage Becomes Unconventional

What happens when something that’s thought to be conventional doesn’t work for the masses anymore? The unconventional becomes the standard, of course! And that’s precisely what has happened in the North American real estate industry over the last decade or so.

In North America, a conventional loan is defined as a 30-year fixed rate mortgage loan for 80% (or less) of a home’s appraised value and that does not require insurance backing. That’s a mouthful, right? Well, here’s how a conventional loan would be described in a real-world scenario:

A couple is interested in purchasing a $ 200,000 home. They have a $ 40,000 ($ 200,000 x 20%) down payment and are therefore only in need of a $ 160,000 loan to purchase the home. A lender agrees to finance the $ 160,000 loan at an unchanging 5.25% interest rate since the couple has a 730 credit score. The couple agrees to re-pay the mortgage loan with equal payments over the next 30 years.

Now, the question is: Do you have $ 40,000 in the bank saved up for a home and a 700+ credit score?

If you do, congrats! You can probably purchase a home with a conventional loan. However, if you’re like most potential homebuyers you don’t…and that’s okay too. Remember how I said that unconventional is becoming the standard. Well, I meant it. These days, most people just cannot afford to save $ 20,000 for a down payment, let alone $ 40,000, $ 60,000, or $ 80,000; most people cannot meet the 700+ credit scores lenders are requiring either. That’s why unconventional loans are so popular these days.

“What’s an unconventional loan?” you ask. Well, it’s literally any loan that’s not a conventional loan, which means there’s a wide range of possibilities! Here’s a look at some of the more common types of unconventional loans available today:

Variable Rate Mortgages
Variable rate mortgages, which are sometimes called adjustable rate mortgages (ARMs), are mortgage loans on which the interest changes based on current market conditions.

There are a variety of combinations for this type of loan. You could have a 100% ARM, a fixed-adjustable loan (example: a 5-1 hybrid mortgage), or an adjustable-fixed loan (example: a 2/28 mortgage). ARMs are popular with homebuyers and home investors.

Interest-only Mortgages
Interest-only mortgages work just as the name implies…well, almost. Typically, interest only mortgage loans require a borrower only to pay interest on the loan but the principal does at have to be repaid at some point. After the initial interest-only period, the mortgage payments increase so that the interest and principal will be paid off within the timeframe of the original loan. Though some homebuyers do opt for a partial interest-only mortgage, this type of loan is most appealing to real estate investors.

No Doc Mortgage Loans
No Doc mortgages do not require borrowers to present financial or employment documentation in order to be eligible for a loan. Borrowers must still have a stellar credit history in order to qualify for No Doc loans though. Also, the price for scooting by without having to show documents to verify income and employment is usually a higher interest rate, and sometimes even a higher down payment than would otherwise be required of a borrower. No Doc loans are a common choice for people who are self-employed or independent contractors simply because they usually don’t have the same financial and employment documentation available to them as people who are employed by someone else.

Short-term & Extended-term Mortgages
Another type of unconventional loan has to do with the loan term. Conventional loans have a term of 30 years. However, unconventional loan terms can be longer or shorter. Shorter mortgage loan terms are usually for 5, 10, or 15 years; extended mortgages are typically no longer than 40 years.

Additional types of common unconventional loans include Negative Amortization loans, No Income / No Asset (NINA) mortgages, and No Income / No Job / No Asset (NINJA) mortgage loans. I only mention those because they are available. However, they are not recommended; if those are the only types of mortgage loans for which you can qualify, it’s likely that the mortgage you’re trying to obtain is more than you can afford. (Sorry if I busted any bubbles but it’s true!) Plus, because of the high interest and mortgage payments that always result from these types of loans, you’d be better off financially in the long run waiting a year or two to purchase a home.

Unconventional loans make it possible for those who would otherwise be unable to buy a home to be homeowners. However, this “work around” for the conventional loan is often a more costly decision for homebuyers. Therefore, be sure to weigh your options carefully when you decide it’s time to become a homeowner. If an unconventional loan makes sense for you, go for it! If not, consider waiting a year or two to buy and use that time to get your finances

 

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