What is a Conventional Loan?
Conventional loans are in a category by themselves and offer borrowers many benefits.
Are you deciding which loan program is right for you? There are many options, including government-backed and conventional loans.
What is a Conventional Mortgage Loan?
A conventional loan is a common type of mortgage that is not backed by a government agency and is provided by private lenders such as mortgage bankers, credit unions, mortgage brokers, and federal banks.
Conventional is considered to be a bit more difficult to qualify for than government-backed home loans.
There are two types of conventional loans: conforming and non-conforming.
- Conforming: adheres to the guidelines set by government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac.
These guidelines include credit score requirements, maximum loan limits, debt-to-income ratios, and down payment requirements.
There are also guidelines on the type of properties that are eligible for the loan program.
- Non-conforming loan: does not adhere to these guidelines and are not usually sold to the GSEs.
Each option has its own advantages and different qualifications for eligibility.
Conventional loans have several types, including:
- Conforming loans – Conforming conventional loans meet the Fannie Mae and Freddie Mac guidelines and are for less than the conforming loan limit of $726,200. This means Fannie Mae or Freddie Mac buys the loan on the secondary market. As a result, they offer the most competitive rates and terms.
- Jumbo loans – These loans are for a loan amount above $726,200 and aren’t backed by Fannie Mae or Freddie Mac. Lenders keep jumbo loans on their books and often require higher credit scores, lower debt ratios, and more assets to qualify.
- Portfolio loans – A portfolio loan is a conventional loan that the lender chooses to retain in their own portfolio instead of selling it on the secondary market. This allows the lender more flexibility in terms of credit score and debt-to-income ratios beyond what is typically allowed by Fannie Mae and Freddie Mac.
- Adjustable-rate loans, also known as adjustable mortgages, are a type of loan where the interest rate changes over time. With a fixed-rate mortgage, the interest rate remains the same throughout the life of the loan, resulting in a consistent monthly payment. However, an adjustable-rate mortgage typically starts with a fixed rate for a set period (usually 3 to 10 years), after which the interest rate may adjust annually based on market conditions.
Conventional Qualifying Requirements
The eligibility requirements for a conventional loan can vary depending on the type of loan, but generally, borrowers need:
- Have a good credit history, with a credit score of 620 or higher (this may vary by lender)
- Provide evidence you have funds for a down payment and the closing costs.
- Show you have stable and consistent employment.
- Have a debt-to-income ratio that doesn’t exceed 50% of your gross monthly income.
More conventional related info:
Each lender has different qualifying requirements, but these are the average requirements most lenders want unless you’re applying for a jumbo or portfolio loan.
In those cases, lenders may have stricter (or looser) guidelines.
5 Reasons to Choose a Conventional Loan
Conventional loans have many benefits and many reasons to choose them.
However, understanding what sets them apart from the other loans available is important to help you decide which is right for you.
Low Down Payment Requirements
Contrary to popular belief, borrowers don’t need a 20% down payment on conventional loans. Some first-time homebuyers can put down as little as 3%, and borrowers who owned a home before can put down as little as 5%.
You will pay Private Mortgage Insurance if you put down less than 20%, but it doesn’t last forever. When you pay the loan balance down to less than 20% of the home’s value, you can ask the lender to cancel PMI.
The amount of PMI you’ll pay depends on your loan amount and credit score.
The less you borrow and the higher your credit score, the lower the PMI rate you’ll pay.
The only exception to this rule is jumbo loans. Most lenders require a larger down payment to make up for the risk of the larger loan amount.
A Choice of Terms
Conventional loans are available in several terms, including fixed and adjustable-rate loans.
You can decide which loan type works best for you. For example, if this is your ‘forever’ home, you may want a fixed rate, so you don’t have to worry about your mortgage payment changing.
You’ll know for the life of the term what your payment will be.
However, if you know you’ll move in a few years or your income will change, you may want an adjustable-rate loan.
The benefit of ARMs is you get a lower introductory rate to save money for a few years before the rate adjusts annually. If you move or refinance the loan before it adjusts, you don’t have to deal with the changing interest rate.
You can also choose your loan term, between 15 and 30 years.
If you can afford a 15-year payment, you’ll pay the loan off in half the time and pay less interest.
But, if you need a lower monthly payment, you can stretch the payments across 30 years or a term between 15 and 30 years.
Most Homes and Living Situations Qualify
Unlike FHA and VA loans, conventional loans don’t restrict you to a primary residence only.
You can use conventional loan financing for any of the following:
- Primary residence
- Second home
- Vacation home
- Investment home
In addition, conventional loans work on most property types, including:
- Single-family homes
- Manufactured homes
You don’t have to live in a certain area, like USDA loans, and you can use the home for any purpose as you prove you can comfortably afford the payments.
Competitive Interest Rates
Conventional loans usually offer low-interest rates or at least competitive rates compared to other loan programs.
They work on a sliding scale, with borrowers with great credit scores and low debt ratios getting the best rates.
Conversely, borrowers with less-than-perfect credit may still qualify but pay slightly higher PMI rates.
Conventional loans are completely transparent about the rates and terms offered, so you know upfront what you’ll pay.
Sellers Prefer Conventional Loans
There’s nothing wrong with government-backed loans, but sellers in a rush to sell their home or with many offers tend to favor conventional loans versus government-backed loans.
Many sellers assume government-backed loans have too much paperwork and restrictions, limiting their ability to sell the home quickly.
There are rarely any reservations about a buyer with conventional financing.
Conventional loans offer many benefits to borrowers, allowing you to get affordable financing.
You may be a good candidate for conventional financing if you have average credit scores and debt ratios.
Explore your options and compare them side-by-side, looking at the monthly payment and the loan’s total cost to determine which loan is right for you.
No two borrowers will have the same loan needs, so the right loan for you might be different than the right loan for your neighbor.
Let us help you find the perfect loan for your situation!
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