4.2 Loan Types and Government Programs

Conventional Loans: Conforming and Jumbo

A conventional loan is any mortgage not insured or guaranteed by the government. Conventional loans divide into two groups based on size:

• Conforming loans meet the underwriting and dollar limits set by Fannie Mae and Freddie Mac, so they can be sold on the secondary market. The 2026 baseline conforming limit for a one-unit property is $806,500 in most counties, with higher ceilings in designated high-cost areas.
• Jumbo (non-conforming) loans exceed the conforming limit. Because Fannie and Freddie will not buy them, jumbo loans carry stricter credit, reserve, and down-payment requirements.

Private Mortgage Insurance (PMI)

When a conventional borrower puts down less than 20% — meaning a loan-to-value (LTV) ratio above 80% — the lender requires private mortgage insurance (PMI). PMI protects the lender, not the borrower, against default loss. Under the Homeowners Protection Act, the borrower may request cancellation at 80% LTV of the original value, and the lender must automatically terminate PMI at 78% of original value (assuming the loan is current).

Government-Backed Programs: FHA, VA, USDA

FHA loans are insured by the FHA; the agency does not lend money but reimburses lenders for losses. Borrowers pay mortgage insurance premium (MIP) in two parts — an upfront MIP of 1.75% of the loan (usually financed) plus an annual MIP collected monthly. FHA allows lower credit scores and a 3.5% minimum down payment.

VA loans are guaranteed (not insured) for eligible veterans and service members. The VA guarantees a portion of the loan, called the veteran's entitlement, letting lenders offer 100% financing with no down payment and no monthly mortgage insurance. In place of insurance, the borrower pays a one-time funding fee (2.15% for a first-time, zero-down purchase), which can be financed and is waived for veterans with a service-connected disability.

USDA loans (Rural Development) offer zero-down financing in eligible rural and suburban areas, subject to household income limits. The property must lie within a USDA-designated rural area, and the borrower's household income generally cannot exceed 115% of the area median income.

Insured vs. Guaranteed — A Tested Distinction

Watch the wording: the FHA insures loans, the VA and USDA guarantee them, and conventional borrowers buy private insurance. In all cases the protection runs to the lender, reimbursing it for default loss so it will accept a smaller down payment. The borrower pays for that protection — through MIP (FHA), a funding fee (VA), a guarantee fee (USDA), or PMI (conventional) — yet receives none of its benefit. A frequent exam trap is to call FHA a lender; it is not. Neither FHA nor VA hands money to buyers. They make lenders willing to lend by absorbing the risk.

Fixed vs. Adjustable Rates and Amortization

A fixed-rate mortgage keeps the same interest rate and payment for the entire term. An adjustable-rate mortgage (ARM) has a rate that changes periodically. Three components drive an ARM, and the exam tests each:

• Index: a published benchmark rate (e.g., SOFR) that moves with the market.
• Margin: a fixed percentage the lender adds to the index. Index + margin = the fully indexed rate.
• Caps: limits on how much the rate can rise — an initial cap (first adjustment), a periodic cap (each subsequent adjustment), and a lifetime cap (maximum over the loan's life). A common "2/2/5" cap structure means 2% initial, 2% periodic, 5% lifetime.

Amortization Types

• Fully amortizing: equal payments retire the loan exactly by maturity; a $0 balance remains.
• Partially amortizing (balloon): payments are too small to retire the loan, so a large balloon payment of remaining principal is due at the end of a shorter term.
• Negative amortization: the payment is less than the interest owed, so unpaid interest is added to principal and the balance grows.
• Interest-only: payments cover interest only; principal is unchanged until amortization begins or a balloon is due.

Points, Buydowns, and Loan-to-Value

A discount point equals 1% of the loan amount and is prepaid interest the borrower pays at closing to lower the interest rate — "buying down" the rate. As a rule of thumb, one point lowers the rate by roughly 0.25%, though this varies.An origination point is a charge for processing the loan and does not reduce the rate.

A buydown temporarily or permanently reduces the borrower's rate. In a temporary buydown (such as a 2-1 buydown), the rate is reduced for the first year or two — often funded by the seller or builder — then steps up to the note rate. A permanent buydown uses discount points to lower the rate for the full term.

Loan-to-Value (LTV)

LTV ratio = loan amount ÷ the lesser of sale price or appraised value, expressed as a percent. On a $300,000 home with a $240,000 loan, LTV is 80% ($240,000 ÷ $300,000). LTV drives:

• Whether PMI or MIP is required (conventional PMI kicks in above 80%).
• The down payment (a 90% LTV means a 10% down payment).
• Lender risk — a higher LTV means less borrower equity and greater default risk.

If the appraisal comes in below the contract price, LTV is calculated against the lower appraised value, often forcing the buyer to pay the difference in cash or renegotiate.