A house is a significant purchase that often leads buyers to seek financing in the form of a home loan. There are several different types of loans available, and the right choice will depend on the borrowers’ income, debt, down payment, desired interest rate and credit score, among other factors. So, exactly what is a conventional home loan?
What Qualifies As A Conventional Loan?
A conventional loan is a type of mortgage loan used to buy a house that is not backed by a government agency. These loans are issued by banks and other lending institutions.
There are two main types of conventional loans: conforming and non-conforming. The conforming variety follow rules for lending established by the Federal National Mortgage Association, also known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, or Freddie Mac. There is a maximum loan amount that applies to mortgages; this can vary by year and geographical location.
Non-conforming loans do not follow these rules and offer slightly more flexibility. For example, one popular type of non-conforming loan is a jumbo loan for homes with higher price tags.
How A Conventional Loan Works
Borrowers who are seeking a conventional loan must go through a private mortgage lender such as a bank or credit union. They will be asked to fill out an application and present financial documents. The lending institution will then assess their credit score and financial situation to determine their approval likelihood and their interest rate once approved.
The interest rate will depend on the borrower’s credit score and overall credit history, with those who have better credit paying less in interest throughout the life of the loan.
Down payments vary, with some financial institutions accepting a down payment of as low as 3 percent. However, lenders often require those who do not put down at least 20 percent to pay private mortgage insurance, which may equate to as much as 1.5 percent of the loan amount per year.
How Is a Conventional Loan Different From a Government-Backed Loan?
Many financial institutions offer both conventional loans and government-backed loans, and the right option will depend on the borrower’s circumstances.
Outlined below are some of the government-insured mortgage options that may be a good fit for certain groups of homebuyers.
A Federal Housing Administration, or FHA, loan allows borrowers to buy a home with a credit score of as low as 500 as long as they can make a down payment of 10 percent; those with a credit score of 580 can make a 3.5 percent down payment. An FHA loan is considered a good option for those whose credit scores are not high enough to qualify for conventional loans.
A loan from the U.S. Department of Veterans Affairs, or VA loan, does not require any down payment, nor does it charge private mortgage insurance. This type of loan is only available to selected members of the military, their spouses and other beneficiaries.
A USDA loan is insured by the U.S. Department of Agriculture and enables homebuyers with a low-to-moderate income to purchase homes in eligible rural areas. This type of loan does not require a down payment, and it also offers greater flexibility when it comes to credit score requirements. Although these types of loans are insured by government agencies, they are issued by the same private lenders who offer conventional loans. A borrower with a high credit score above 740 who can afford to pay 20 percent down on their new home might get the best interest rate and lowest fees from a conventional mortgage.
Another benefit of a conventional loan is the potential higher loan limit and a greater degree of flexibility when it comes to payment options and term lengths. However, the stricter qualifying guidelines and higher credit score and down payment requirements can be a significant obstacle to some borrowers. Those who have lower credit scores might find FHA loans easier to obtain. However, it is important to keep in mind that FHA loans charge a mortgage insurance premium that contains an upfront fee as well as recurring charges that can make the mortgage cost more over time.
Borrowers who are concerned about the mortgage insurance premium on an FHA loan should try to improve their credit score prior to applying for a mortgage as this can help them quality for a conventional loan and might also lower the loan’s fees and interest rate.
Contact A Mortgage Lender
Purchasing a home is a major decision, so it is important to shop around for the best rates and carefully consider your loan options before making a commitment. If you are ready to learn more about how you can finance an upcoming home purchase, get in touch with the mortgage lenders at My Lending Pal to find out about the options that are right for you.