What is a conventional home loan?
When shopping for a mortgage, the type of loan you’re most likely to land on is what’s known as a conventional mortgage—the most common mortgage type offered by most lenders.
A conventional home loan is any type of loan offered to home buyers that is not secured by a government entity. Rather, conventional loans are offered through private lenders like banks, credit unions, and mortgage companies. Most conventional mortgages are ‘conforming,’ which simply means they meet the basic requirements set by the Federal Housing Finance Agency (FHFA). Exceptions to this rule include jumbo mortgages, which, while still deemed conventional, exceed typical borrowing limits.
Conventional loans vs government-backed loans
When comparing conventional loans to government-backed loans, keep the following points in mind:
- Conventional loan interest rates tend to be higher than those of government-backed mortgages with special eligibility requirements, such as the Federal Housing Administration (FHA), the U.S. Department of Veterans Affairs (VA), and the USDA Rural Housing Service. However, these loans usually require borrowers to pay insurance premiums, which can sometimes cost just as much in the longterm.
- Unlike government-backed loans, eligibility for conventional loans isn’t limited based on income, location, or military status.
- Government-backed loans are insured by federal agencies, which protects the lender in the event that the borrower can’t repay the loan. Conventional loans are generally viewed as riskier by lenders because they’re not guaranteed by the government, so they tend to have stricter requirements.
Conventional loan requirements
- Conventional loans tend to be the best option for borrowers with strong credit who can afford a minimum down payment of 3%. Of course, the higher your down payment, the easier it is to get a lower interest rate.
- If you’re refinancing, however, you’ll need at least 5% equity. When refinancing a jumbo loan, you’ll need 10.01% to 25% equity, depending on the amount of the loan.
- Typically, you’ll need a credit score of at least 620, but a score above 740 will get you a better rate.
- The majority of conventional loans require that your debt-to-income ratio (a percentage that represents how much of your monthly income goes to paying down debt) be 50% or lower.
Advantages of conventional loans
- Generally, conventional loans offer more options for property types than government-backed loans do. For instance, they can be used for jumbo loans, as well as for a second home, or an investment property.
- If your down payment is under 20%, you’ll need to get private mortgage insurance (PMI). However, once your principal loan balance drops to 78% of your home’s value, you can request a cancellation of your PMI. This is not the case for many government-backed loans.
- Conventional loans don’t ask for the additional program-specific fees associated with government-backed loans (for example, FHA loans ask for a 1.75% upfront mortgage insurance premium).
- Although 30-year fixed-rate conventional mortgages are most common, you have options when it comes to choosing your loan structure that those in government-backed programs often don’t. You might talk to your mortgage broker to learn more about 15 or 20-year loans, and/or adjustable rather than fixed rate mortgages.
There are few things more exciting than buying a new home, but remember, knowledge is power when it comes to selecting the home loan that best suits your circumstances. Here’s to landing the best conventional mortgage available to you!