Until the mid-1930s, the most common form of real estate financing was the "straight" loan, a term mortgage with a five-year life and semi-annual interest payments. Straight loans were attractive years ago because interest rates were low and there was plenty of cash available when refinancing was necessary.
But the Depression and the harsh weather in the mid-west--the Dust Bowl--brought out the worst features of the straight loan system. People who were unemployed could not make semi-annual interest payments, farms where crops no longer grew were not acceptable collateral for new financing and many lenders failed, shutting off valued sources of community cash and credit. The inevitable result was a rash of foreclosures and calls for a new system of home financing.
That new system arose in the 1930s when the Federal Housing Administration (FHA) popularized the long-term, self-amortizing home loan, a concept which we today regard as "conventional" financing.
A conventional loan is the benchmark against which all other mortgage concepts may be measured and such loans are distinguished by five central features.
*Set Monthly Payments: Each month the borrower makes payments which are substantially equal during the life of the mortgage.
*Set Interest Rate: The interest rates is established at the time the loan is first created and remains unchanged during the term of the loan.
*Loan term: Most conventional loans are designed to be repaid over an extended period of time, usually 30 years.
*Amortization: Conventional financing is arranged so that the entire loan, including all interest and principal, will be completely repaid during the term of the mortgage. As a result there are no "balloon" payments associated with conventional loans and refinancing at the end of the mortgage is not required.
*Coverage: Conventional loans are available in those cases where a buyer puts down at least 20 percent of the purchase price of a property in cash.
With these factors in mind, a conventional sale might look like this: Buyer Smith purchases a new home for $100,000. Of this amount, $20,000 is represented by the cash down payment paid by Smith at settlement and the remaining $80,000 is in the form of a 30-year mortgage from a local lender. At the end of 30 years, Buyer Smith owns the property free and clear of any mortgage debt.
Conventional loans are appealing to lenders because such financing assures limited risk. The buyer's down payment creates a deep cushion which protects the lender in the event of a foreclosure. If the house must be auctioned, the lender's interest will be protected if the property sells for $80,000 plus the cost of the foreclosure action.
Conventional loans are a useful index against which individual lenders can be compared. Unlike other forms of financing, conventional mortgages are commonly offered by all community lenders and since the terms and conditions of conventional loans are standardized, it is an easy matter to determine which lender has the best available rates and terms. Here are questions to ask local mortgage loan officers about conventional financing.
Are you currently making 30-year, fixed rate, self-amortizing home mortgages?
If not, do you know who is making such loans?
What is your current rate of interest?
In addition to the current interest rate, are "points" or loan discount fees being charged? If so, how many?
Are your current interest rate, points and other terms locked in at this time or could they change by settlement? Some lenders guarantee rates and terms at the time of application, a definite advantage for purchasers in a market when interest costs are rising.
In general terms, how much income will I need to qualify for a conventional loan of X dollars?
Next Week: Second trusts
Correction: In the column of April 9, the size of a balloon payment for a $50,000 second trust with monthly payments of $500 was incorrectly stated. The proper amount is $78,252.88.