A conventional loan is a type of mortgage that is not part of a specific government program, such as Federal Housing Administration (FHA), Department of Agriculture (USDA) or the Department of Veterans’ Affairs (VA) loan programs. However, conventional loans are commonly interchangeable with “conforming loans”, since they are required to conform to Fannie Mae and Freddie Mac’s underwriting requirements and loan limits.
Because conventional loans offer so much flexibility, there are still some decisions you have to make even after you choose this loan type. You’ll also have to consider how much you can put down, how long you want your loan term to be, and how much house you can afford.
Without the backing of the government, conventional loan borrowers pose a bigger risk to the institutions who issue the mortgage. As such, borrowers must meet three basic requirements.
The standard down payment for a conventional loan is anywhere between 3 and 25 percent of a home’s value depending on the borrower’s credit and financial condition. For example, a $100,000 home could require a $20,000 down payment.
However, depending on a lender’s unique specifications, a borrower may be able to put down as little as 3 percent at closing. Just keep in mind, this option is typically only available to those who meet additional requirements, like being a first-time homebuyer. Remember, with a larger down payment, homeowners also enjoy immediate equity in their home.
To qualify for a conventional loan, your monthly mortgage payments and monthly non-mortgage debts must fall within certain ranges. For instance, a lender may require your monthly mortgage payments (which may include taxes and insurance) not exceed 28 percent of your gross monthly income. In addition, your monthly mortgage payments, when combined with your other monthly debt payments (car loans, student loans, credit card bills, etc.), may be limited to a maximum of 36 percent of your gross monthly income.
Your credit score also plays an integral role when qualifying for a conventional loan. In fact, most lenders require a minimum FICO credit score of around 620 to obtain approval.
A conventional loan is a type of mortgage loan that is not insured or guaranteed by the government. Instead, the loan is backed by private lenders, and its insurance is usually paid by the borrower.
When you’re thinking about your mortgage options, it’s important to understand the difference between conventional loans and government-backed loans.
Government-backed loans include options like VA loans—which are available to United States Veterans—and Federal Housing Administration (FHA) loans. FHA loans are backed by the Federal Housing Administration, and VA loans are guaranteed by the Veterans Administration.
With an FHA loan, you’re required to put at least 3.5% down and pay MIP (mortgage insurance premium) as part of your monthly mortgage payment. The FHA uses money made from MIP to pay lenders if you default on your loan.
To qualify for a VA loan, you must be a previous or current member of the U.S. Armed Forces or National Guard—or have an eligible surviving spouse. A VA loan requires no down payment, but you must pay a one-time funding fee, which usually ranges from 1%–3% of the loan amount.
With a conventional loan, the lender is at risk if you default. If you can no longer make payments, the lender will try to recoup as much of the remaining balance as they can by selling your house through a short sale process or even foreclosure. You didn’t think borrowers get out of not paying for their house, did you? No way!
Because of this additional risk to the lender, you’re required to pay private mortgage insurance (PMI) on a conventional loan if you put less than 20% down.
In order to be considered a conforming conventional loan, the loan must meet the guidelines set by Fannie Mae and Freddie Mac. No, those aren’t your friendly neighborhood grandparents. Fannie Mae (short for the Federal National Mortgage Association) and Freddie Mac (short for the Federal Home Loan Mortgage Corporation) are government-sponsored enterprises that purchase mortgages from lenders.
One of Fannie Mae and Freddie Mac’s most important ground rules is loan limit. For 2018, the baseline loan limit for one-unit properties is $453,100. It’s called baseline because the maximum amount—or limit—you can borrow is adjusted every year to match housing-price changes. In certain high-cost areas, the loan limit may increase to a maximum of $679,650.(2)
Check with your lender to see what the conforming loan limits are for your area.
What about conventional loans that exceed the loan limit? These are considered non-conforming conventional loans.
Simply put, a non-conforming conventional loan (also referred to as a jumbo loan) is a conventional loan not purchased by Fannie Mae or Freddie Mac because it doesn’t meet the loan amount requirements. Instead, non-conforming loans are funded by lenders or private institutions.
