What is a conventional loan?

If you are new to mortgages, you are probably getting familiar with loan types, and the most common is the conventional loan. The simplest way to think about a conventional loan–it’s a private loan from a lender to purchase a house. These loans are not backed by a government agency and are provided by private companies (banks/lenders/investors). 

To complicate things a little, Conventional loans are broken down into "conforming" and "non-conforming" loans.

Conforming loans have lending rules set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). However, we offer some flexibility with non-conforming conventional loans.

What is the advantage of a conventional loan?

Keep in mind, there is no "best mortgage". Everyone has different goals and different circumstances. Some of us have lots of assets, some of us have different income levels, some of us have good credit, and some of us have not so great credit. All of these factors determine what type of mortgage is best for you.

In general, here are some advantages of a conventional loan as noted by Experian.

Low Interest Rates

Because your interest rate on a conventional loan based on your credit, among other factors, a high credit score can help you qualify for a low interest rate. You can avoid mortgage insurance with a 20% downpayment or you can request to have the insurance requirement removed once your loan-to-value ratio reaches 80%. In contrast, the mortgage insurance premium that comes with an FHA loan may stay on there for the life of the loan.

Higher Loan Limits

While conforming loans do have limits, you can go even higher with jumbo conventional loans if you need to. You may not get that kind of flexibility with government-insured loans.

Flexibility

Private mortgage lenders have more flexibility with conventional loans than they do with government-insured loans, primarily because they don't need to follow the guidelines set by those government agencies.

As a result, you may have an easier time finding a conventional loan with flexible down payment options and term lengths, not to mention opportunities to get a loan if your credit doesn't meet the standards for a government-insured or conforming loan.

Why would I avoid a conventional loan?

Higher Credit Score Requirements

You simply might not qualify for a conventional loan. Conventional loans require high credit scores. Most are in the 700s some are as low as  620 to qualify. On a conventional loan, the higher the credit score the better the rate and lower the private mortgage insurance (PMI) if less than 20 percent down.

In contrast, you can qualify for an FHA loan with a much lower credit score. FHA regulations are always changing. Contact us for the most recent requirements.

Down Payment Requirements

Higher down payment will be required if you want a lower interest rate and to avoid private mortgage insurance.

Stricter Qualifying Guidelines

Government-insured mortgage loans place less risk on the mortgage lender, so it may be easier to qualify for one of those, as long as you meet the agency's eligibility requirements.

With a conventional loan, on the other hand, your personal financial situation may be scrutinized more closely because the lender is taking on more risk by originating the loan.

How does the conventional mortgage work?

There are several types of conventional loans that you may come across as you compare lenders and mortgage options. Here are some of the most common ones and how they work according to Experian.

Conforming Conventional Loans

Conforming conventional loans are loans that adhere to the standards set by Fannie Mae and Freddie Mac, including maximum loan amounts.

Jumbo Conventional Loans

If you want to borrow more than the lending limits for conforming loans, you should look for lenders that specialize in jumbo mortgage loans.

Jumbo loans typically require higher credit scores than conforming loans (think 700 or higher), and you may also need to have a lower debt-to-income ratio (DTI) and put down a larger down payment.

Even with those things, you may end up with a higher interest rate than a conforming loan because the larger loan amount represents a bigger risk to the lender.

Portfolio Loans

A portfolio loan is a conventional loan that a lender chooses to keep in its own portfolio rather than selling it on the secondary market—something that's common but requires that loans meet Fannie Mae's and Freddie Mac's standards.

A portfolio loan gives lenders more flexibility with underwriting, which can be good for you if you have a low credit score or high DTI.

However, portfolio loans tend to come with higher interest rates and don't have all the same consumer protections that come with conforming loans.

Subprime Conventional Loans

Conforming loans require that you have a debt-to-income ratio below 50% and a credit score of 620 or higher. But if your credit isn't quite there, you may qualify for a subprime mortgage loan.

These loans are non-conforming and may charge high closing costs and interest rates. However, they can also provide a way to get into a home without needing to wait until your credit is in excellent shape.

Amortized Conventional Loans

These loans are fully amortized, giving homebuyers a set monthly payment from the beginning to the end of the loan repayment period, without a balloon payment. Amortized conventional loans can have fixed or adjustable mortgage rates.

Adjustable Conventional Loans

A fixed-rate mortgage loan has the same interest rate—and, therefore, the same monthly payment—throughout the life of the loan. With an adjustable-rate mortgage loan, however, you'll get a fixed interest rate for a set period, typically between three and 10 years. After that, your interest rate can adjust each year based on the current market rates.

Adjustable conventional loans typically have lower interest rates than fixed conventional loans in the beginning, but their cost can be higher overall if market mortgage rates increase over time.