Conventional Loan 101: The Two Types of Conventional Loans

A conventional loan is any type of mortgage loan you acquire from a private lender as opposed to a government institution. They come from banks and credit unions rather than the government itself.

Keep in mind, a conventional loan might still receive some degree of government backing—some conventional loans receive governmental support while others do not. For example, government-sanctioned organizations like Fannie Mae and Freddie Mac back many conventional loans. In addition, the Federal Housing Finance Agency (or FHFA) sets certain guidelines for all conventional loans.

Conventional loans come in a host of different iterations. You can field offers for both adjustable-rate and fixed-rate mortgages, as well as shop around for lenders who will offer you larger loan amounts than are typical.

Conventional loans come from banks, credit unions, and other private institutions, whereas FHA loans come from the Federal Housing Administration.

Since the latter is a government loan program, there are more regulations in place to obtain an FHA loan than a conventional loan in many cases. For instance, the home you buy with an FHA loan must be your primary residence rather than a second home or investment property.

On the other hand, FHA loans allow people with lower credit scores and down payments—who may not qualify for many conventional loans—to obtain money to buy houses. Aside from the FHA, the United States Department of Agriculture (USDA) offers USDA loans to people eager to buy homes in rural areas, and the Department of Veterans Affairs offers VA loans to qualifying former military personnel.

Conventional loans might all be different depending on the lender, but they share some key commonalities. Here are some essential conventional loan requirements and components to consider:

1. 1. Credit score information: Your eligibility for specific conventional loans often relies at least in part on information available on your credit report. Most private lenders look for loan recipients with a credit score of 660 or higher. Those with lower scores have FHA loans as an option.
2. 2. Debt-to-income (DTI) ratio: By checking debt-to-income ratios, banks, credit unions, and other lenders can ensure borrowers have enough money to make their monthly payments. If you have too much outstanding debt with too little income to cover it, you’re liable to be too much of a risk to many mortgage lenders.
3. 3. Down payment: Every conventional loan comes with unique down payment requirements, but most lenders will strive for three to twenty percent at least. First-time homebuyers can take advantage of government programs for lower down payments. Remember closing costs might eat up some of your down payment amount as well.
4. 4. Interest rates: Whether you take out an adjustable-rate mortgage or a fixed-rate loan, you still will pay interest on your initial loan amount. Over the life of the loan, this can account for a lot of extra money, so be vigilant when looking at your interest rate options. A higher credit score often unlocks lower rates. You can also refinance your home at some point in the future to take advantage of lower interest.
5. 5. Loan terms: To purchase a single-family home, you’ll establish a certain time frame in which to pay back your lender. Conventional loans often default to thirty years of monthly payments, but both shorter and longer lengths of time are available as well.

Conventional mortgage loans break down into two primary types: conforming and nonconforming loans. Conforming loans follow the loan limits established by Fannie Mae and Freddie Mac, whereas nonconforming loans do not.

While conforming loan limits for high-cost areas are higher than for more moderately priced areas, they still generally offer lower amounts of money than nonconforming loans do. For example, if a home has a high loan-to-value ratio, a jumbo loan (a nonconforming type of mortgage) might be necessary.

There are pros to using conventional loans. These are some of the core advantages of using a conventional loan on your journey to homeownership:

• Higher limits: Conventional home loans enable you to obtain greater sums of money than government loans do in most cases. You can use online mortgage calculators to see both how much you’d need for your dream home and how much you’ll qualify for with a conventional loan.
• Increased flexibility: Government agencies put more stipulations on their loans, whereas private lenders might be more responsive to your unique financial situation. The increased flexibility might allow you to secure lower monthly mortgage payments lower than you would be able to otherwise.
• More loan options: At the end of the day, there are only a few government loan options available whereas conventional loan types are numerous. This allows you to compare and contrast the advantages and disadvantages of many more options than if you were to simply take out an FHA loan.

Homeowners stand to benefit from heeding certain disadvantages of taking out a conventional loan. Consider these cons:

• Bigger down payments: If a lender signs off on your conventional loan mortgage application, be ready to put more money down upfront. There is the potential to mitigate the cost of this by refinancing in the future.
• Greater potential risk: Qualifying for a conventional loan, especially a nonconforming one, offers you up to a great deal of financial risk. Lenders know this. That’s just one reason why you might have to pay a PMI premium (private mortgage insurance premium) if you don’t put enough money down ahead of time.
• High credit score requirements: You need to have a good credit history to have access to as many mortgage lenders as possible. These high score requirements crowd many people out from taking out conventional loans in the first place.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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