Conventional loans are not insured or guaranteed by any federal government agency. They are originated and funded by private lenders such as banks, credit unions, and mortgage companies. Conventional loans are divided into two categories: conforming loans (which meet Fannie Mae and Freddie Mac guidelines, including loan limits — in 2024, $766,550 for most areas, with higher limits in high-cost CA counties up to $1,149,825) and jumbo loans (which exceed conforming limits and typically require stronger credit and larger down payments). Because no government entity backs them, conventional loans carry stricter credit and underwriting standards. Down payments can be as low as 3–5%, but if LTV exceeds 80%, the lender requires private mortgage insurance (PMI).
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FHA Loans are insured by the Federal Housing Administration. They allow down payments as low as 3.5% for borrowers with credit scores of 580+. A key cost is the Mortgage Insurance Premium (MIP): an upfront MIP (currently 1.75% of the loan amount) plus an annual MIP paid monthly for the life of the loan (if down payment < 10%). FHA loans have loan limits set by county. In California, FHA limits in high-cost metros can exceed $1,000,000.
VA Loans are guaranteed by the Department of Veterans Affairs and are available to eligible veterans, active-duty service members, and surviving spouses. Key features: no down payment required, no PMI, and competitive interest rates. However, a funding fee (typically 1.25–3.3% of the loan amount, depending on down payment and whether it's a first use) is charged unless the borrower has a service-connected disability. VA loans have no set loan limits for eligible borrowers with full entitlement.
USDA Rural Development Loans are backed by the U.S. Department of Agriculture for properties in eligible rural and suburban areas. They offer 100% financing (no down payment) and low mortgage insurance costs, but income limits apply and the property must be in a USDA-designated area. Some parts of Northern California qualify.
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A fixed-rate mortgage (FRM) carries the same interest rate and monthly principal + interest payment for the entire loan term (10, 15, 20, or 30 years). Predictability is the main advantage — the borrower always knows what they owe each month.
An adjustable-rate mortgage (ARM) has an initial fixed-rate period, after which the rate adjusts periodically based on a benchmark index (such as SOFR or CMT) plus a margin set by the lender. A "5/1 ARM" is fixed for 5 years, then adjusts annually. ARMs have two types of caps: periodic caps (limit how much the rate can change at each adjustment, e.g., 2%) and lifetime caps (limit total change over the life of the loan, e.g., 5%). ARMs often start with lower rates than fixed-rate loans, making them attractive for short-term buyers — common in California's high-cost market.
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Interest-only loans require only interest payments for an initial period (typically 5–10 years), after which the loan recasts and the borrower makes fully amortizing payments. Monthly payments are lower initially but spike after recasting.
Balloon mortgages have regular amortizing payments but require a large lump-sum "balloon" payment at the end of the loan term (e.g., 5 or 7 years). At that point, the borrower must refinance, sell, or pay off the balance. Risk: if rates rise or credit tightens, refinancing may not be possible.
Bridge loans are short-term financing used to bridge the gap when a buyer wants to purchase a new home before their current home sells. High interest rates and fees. Common among move-up buyers in competitive CA markets.
Hard money loans are asset-based (secured by the property value, not borrower creditworthiness), offered by private investors rather than banks. Features: very high interest rates (8–15%+), short terms (6–24 months), fast funding, used by investors for fix-and-flip properties or when traditional financing isn't available.
Purchase money mortgage — the seller acts as the lender, financing part or all of the purchase price. Important in CA: these loans receive anti-deficiency protection (the lender/seller cannot sue for a deficiency after foreclosure).
Construction loans finance the building of a new home. Funds are disbursed in draws as construction milestones are reached. Once construction is complete, the loan converts to a permanent mortgage (construction-to-permanent loan) or is paid off with a new mortgage.
Biweekly mortgages — the borrower makes half the monthly payment every two weeks, resulting in 26 half-payments (13 full payments) per year instead of 12. The extra payment reduces principal faster, shortening the loan term and saving significant interest.
Negative amortization occurs when monthly payments are less than the interest accruing, so unpaid interest is added to the loan balance. The loan balance grows over time rather than shrinking. This feature was common in Option ARMs before the 2008 crisis and is now heavily regulated.
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Discount points are prepaid interest paid at closing to permanently reduce the interest rate. Each point equals 1% of the loan amount. Paying 2 points on a $500,000 loan costs $10,000 upfront but lowers the rate (e.g., from 7.0% to 6.5%). The "break-even" period determines whether buying points makes financial sense.
Origination points are lender fees for processing the loan, not tied to rate reduction. Also expressed as a percentage of the loan amount.
Example: On a $600,000 CA home loan, 1 discount point = $6,000 paid at closing.
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Quiz Questions:
Q1. A borrower wants a government-backed loan that requires no down payment and no private mortgage insurance. Which loan type best fits?
A) FHA loan B) Conventional conforming loan C) VA loan D) Jumbo loan
Answer: C — VA loans require no down payment and no PMI. They charge a funding fee instead, which can be rolled into the loan. FHA requires a 3.5% down and MIP; conventional requires PMI if LTV > 80%; jumbo is not government-backed.
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Q2. A property investor needs fast funding to purchase a distressed property and plans to renovate and sell within 12 months. Traditional bank financing is unavailable due to the property's condition. Which loan is most appropriate?
A) FHA loan B) USDA Rural Development loan C) Hard money loan D) Biweekly mortgage
Answer: C — Hard money loans are asset-based, close quickly, and are designed for short-term investment scenarios like fix-and-flip. FHA and USDA have strict property condition requirements. A biweekly mortgage is a payment structure, not a loan type.
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Q3. A lender quotes a 30-year fixed rate loan at 6.75% with 0 points, or 6.25% with 2 discount points. The loan amount is $500,000. What is the dollar cost of the 2 discount points?
A) $5,000 B) $10,000 C) $12,500 D) $2,500
Answer: B — 1 discount point = 1% of the loan amount. 2 points × $500,000 = $10,000.
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Q4. Which of the following is TRUE about a 5/1 ARM?
A) The rate is fixed for 1 year, then adjusts every 5 years B) The rate is fixed for 5 years, then adjusts annually C) The rate adjusts every 5 months D) The loan is paid off in 5 years with a balloon payment
Answer: B — A 5/1 ARM has a fixed rate for the first 5 years, then adjusts once per year based on a benchmark index plus margin. The first number is the fixed period; the second is the adjustment frequency.
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Q5. Which loan type results in the loan balance INCREASING over time if the borrower makes only the minimum required payment?
A) Fixed-rate mortgage B) Fully amortizing ARM C) Negative amortization loan D) Biweekly mortgage
Answer: C — Negative amortization occurs when minimum payments are less than the interest accruing. The unpaid interest is added to the principal balance, causing it to grow. All other options listed result in a stable or declining balance.