A conventional loan is a mortgage from a commercial lender. Unlike FHA loans, conventional loans are not insured by the federal government. This article reviews conventional mortgages, outlines their benefits, and aims to help buyers decide the best loan type. Conventional mortgages can be a great way to finance a new home.
What is a Conventional Loan?
A conventional loan is a mortgage used to purchase a home. Unlike FHA and VA loans, conventional loans aren’t secured or backed by the federal government.
Conventional loans are among the most common methods of financing a home. While they tend to have stricter eligibility requirements, a conventional mortgage offers many benefits that may not be available through federally insured programs.
For example, conventional loans may offer more competitive rates to buyers who can qualify for stricter lending requirements. A conventional mortgage is readily available through most mortgage lenders.
Types of Conventional Loans
Conventional loans are either conforming or non-conforming. Understanding each loan type can help buyers choose the right mortgage.
Conforming Loans
A conforming conventional loan follows Fannie Mae and Freddie Mac lending guidelines. This means the loan has a similar credit score and down payment requirements as federal loans, and the mortgage lender follows loan amount limits.
While this loan type doesn’t follow the exact lending requirements as Federal Housing Administration (FHA) loans, it does follow conforming loan limits.
The Federal Housing Finance Agency (FHFA) sets loan limits for specific areas based on the local housing market each year. VA, FHA, and conforming loans will only finance up to this particular amount.
Non-Conforming Loans
Not all conventional loans conform to Federal Housing loan limits. Sometimes called jumbo loans, non-conforming loans allow buyers to purchase and finance properties that exceed loan limits. Nonconforming loans may also have less strict credit score requirements, making them an option for some buyers.
Who is Eligible for a Conventional Loan?
Conventional loans have unique eligibility requirements when compared to loans backed by government agencies and typically include the following:
- Credit Score: Conventional mortgages usually require a higher credit score than when compared to FHA loans. Private lenders seek borrowers with higher credit scores to minimize their risk.
- Down Payment: A higher down payment may also be needed with conventional mortgage financing.
- Income: Conventional loan borrowers must show proof of steady employment with consistent income.
- Debt-to-Income Ratio: Conventional loan requirements tend to be stricter than those for government-backed mortgages and often include a lower debt-to-income ratio.
Down Payment and Private Mortgage Insurance (PMI)
A conventional mortgage loan is typically subject to down payment and private mortgage insurance requirements. First-time homebuyers may sometimes qualify for a down payment as low as 3%. However, most conventional mortgage loans require at least 5%. Buyers seeking a minimum down payment might also consider a nonconforming loan.
It’s also important to note that putting less than a 20% down payment on a conventional loan requires mortgage insurance. Private mortgage insurance (PMI) helps protect the lender from defaulting borrowers. The PMI is rolled into the monthly mortgage payment and can sometimes be dropped after reaching a minimum equity in the property.
One advantage of a conventional mortgage over government-insured loans is that it’s usually easier to get rid of PMI on a conventional loan than an FHA loan.
If you don’t want to pay mortgage insurance, you must put at least a 20% down payment on the purchase.
Interest Rates on Conventional Loans
Interest rates refer to the cost of financing a home purchase. Ten-year treasury rates and current buyer demand set interest rates. Buyer’s interest rates vary depending on credit score, loan type, DTI ratio, and down payment. The interest rate you secure directly impacts your monthly payment, so choosing the right loan with the best rates is worth it.
Conventional loans have stricter eligibility requirements because they’re not government-backed loans. While some lenders may allow less-than-perfect credit scores, the buyer usually pays a higher interest rate in return. The loan type also influences the interest rate. Non-conforming conventional loans, including jumbo loans, tend to have a higher interest rate.
A higher interest rate means a higher monthly payment and more interest paid over the life of the loan. Paying down the loan balance faster can help minimize interest paid.
Saving up for a larger down payment and boosting your credit score before applying for a mortgage loan can also help buyers achieve a more competitive interest rate. Always request a copy of your credit report before applying.
Fixed-Rate vs. Adjustable-Rate Mortgages (ARMs)
A conventional loan may also be adjustable-rate or fixed-rate. An adjustable-rate mortgage means the interest rate changes over the loan's length. A fixed-rate loan maintains the same interest rate for the loan repayment period.
Adjustable-rate mortgages offer a more competitive introductory interest rate and lower closing costs. Buyers can also benefit from savings when rates drop. However, rapidly increasing rates can lead to fluctuating mortgage payments, making it difficult for some buyers to budget appropriately.
Fixed-rate mortgages offer predictability and protection from rate increases. In return, buyers may pay a higher introductory rate and miss out on times of lower rates.
Pros and Cons of Conventional Loans
Evaluating the pros and cons of conventional loans can make choosing the right financing for your purchase easier. Here are a few pros of conventional mortgages:
- Flexible Financing: Conventional loans can offer more flexible financing to non-traditional buyers.
- Option of No Mortgage Insurance Premium: A conventional mortgage offers the option of no mortgage insurance premium as long as the buyer puts at least 20% down.
- Lower Rates: When compared to government-backed loans, conventional mortgages may offer buyers better rates.
- Higher Limits: Nonconforming conventional loans allow buyers to exceed the maximum lending limit set by federal departments.
Of course, it’s important to be aware of the potential downsides of a conventional financing loan. Here are a few considerations:
- Higher Credit Score Requirements: Conventional home loan borrowers typically need higher credit scores to qualify.
- Higher Down Payment Requirements: Conventional mortgage lenders usually require a higher down payment.
Is a Conventional Loan Right for You?
Home buyers with an excellent credit history and steady income may benefit from a conventional loan. Conventional loans may also be the best financing choice for nontraditional buyers, such as those who want to purchase using a jumbo loan. Conventional loans offer buyers flexible financing without following Fannie Mae or Freddie Mac rules.
Alternatives to Conventional Loans
Other loan types are available if a conventional mortgage isn’t for you. An FHA loan is a federal mortgage from the Federal Housing Administration. FHA loans have lower down payment and credit score requirements.
VA loans are available through the Department of Veterans Affairs and are geared toward veterans and service members. They offer competitive rates and easier eligibility. FHA and VA are government-backed loans, meaning Fannie Mae and Freddie Mac insure them.
A VA loan offers many of the same benefits as FHA government loans but without any down payment requirements. However, a VA loan may still be subject to a funding fee.
USDA loans are rural development loans. Buyers seeking property in a rural area may benefit from a USDA loan, which offers 0% down payment options and lower rates.
Subprime loans are an option for riskier buyers. They have higher rates but may be the only option for some buyers. Self-employed borrowers also have some non-traditional financing options, such as portfolio loans. A portfolio loan allows buyers to purchase non-conforming properties.
How to Apply for a Conventional Loan
Apply for a conventional mortgage to take the first step toward homeownership. Research available conventional loan programs to find the one that best suits your buying needs.
Today’s buyers have many financing options, sometimes making choosing the right one more difficult. Each buyer’s situation differs, and choosing the loan type that best meets your financial situation and goals offers the best home-buying experience.
Conventional loans offer many benefits over federally-backed financing, including lower interest rates and nontraditional lending. Borrowers with good credit scores, high down payments, and unique buying needs can benefit from a conventional mortgage. Contact TrueWay Mortgage today to learn how a conventional loan can help finance your purchase.
First-time homebuyers, self-employed borrowers, or rural shoppers, TrueWay Mortgage has the expertise to help you finance your dream purchase. Our team is ready to help guide you through the home mortgage process, whether that means a conventional loan (conforming or non-conforming) or another loan type.
