Buying a home is likely one of the biggest financial decisions you’ll make in your life. With so many mortgage options out there, it can be tricky to determine which type of loan is right for your situation. Conventional loans are a popular choice for many homebuyers. Keep reading to learn all about the numerous advantages of conventional mortgages.
More Loan Options
Unlike government-backed loans like FHA or VA loans which have strict requirements, conventional loans offer more flexibility and customization. Borrowers have the choice between fixed-rate or adjustable-rate mortgages. With a fixed-rate loan, the interest rate stays the same for the entire loan term, which is usually 15, 20, or 30 years. Adjustable-rate mortgages start with a low introductory rate that eventually adjusts up or down over time. This wider variety of options makes it easier to find the perfect loan for your budget and financial goals.
Higher Borrowing Limits
Conventional conforming loans have higher lending limits than government loans. The baseline conforming loan limit set by Fannie Mae and Freddie Mac is currently $647200 in most areas but higher limits apply in more expensive housing markets. Jumbo loans are a type of conventional financing that allows even higher borrowing amounts above the conforming limit, up to $1 million or more. This increased purchasing power gives borrowers more choices when shopping for their dream home.
Flexible Interest Rates
Interest rates on conventional loans tend to correlate closely with current market conditions and trends. When rates drop, existing borrowers can refinance to lower their monthly payments. Conversely, adjustable-rate mortgages let you lock in an exceptionally low rate upfront before eventually floating up to the market level over time. This dynamic pricing structure allows smart timing of major financial decisions based on real-time rate fluctuations.
Lower Mortgage Insurance
For borrowers who put down less than 20% on their home purchase, conventional loans typically have lower monthly mortgage insurance premiums compared to FHA loans Additionally, you can request to cancel MI once you reach 20% equity in the home. With an FHA loan, you’d be stuck paying the premium for the entire loan term regardless of your equity position. The ability to remove PMI down the road makes conventional mortgages cheaper over time.
Lower Down Payments
Conventional loans allow down payments as low as 3% for first-time buyers. This lower barrier to entry makes homeownership more accessible for buyers who haven’t accumulated a large down payment nest egg. While FHA loans technically permit 3.5% down, conventional loans don’t charge the additional upfront mortgage insurance premium that FHA borrowers must pay. The lower down payment and upfront costs are a major perk.
Faster Access to Funds
Closing a real estate transaction is a complex process involving multiple parties. Government-backed loans require additional red tape that can slow things down due to extra paperwork and underwriting reviews. Conventional loans are often able to close more quickly because they involve fewer bureaucratic hoops to jump through. You can get the keys and move into your new abode faster.
Potentially Higher Rates
The main trade-off of conventional mortgages compared to government loans is that they may come with slightly higher interest rates. However, for borrowers with good credit, the rate difference is usually pretty negligible. And over the long run, the lower mortgage insurance costs and greater flexibility of conventional loans often outweigh the marginally higher rates.
May Require Mortgage Insurance
If your down payment is less than 20% of the purchase price, you’ll have to pay for private mortgage insurance with a conventional loan. This incremental monthly cost serves to protect the lender in case you default. However, once you build 20% home equity, you can petition to have PMI removed. For borrowers who qualify for low down payment programs, the mortgage insurance costs are well worth the trade-off of getting into a home sooner.
How does a conventional loan work
At its most straightforward, a loan is an amount of money you borrow to buy a home. In exchange for lending the money, you agree to pay interest (and fees) to the lender while you pay the loan back over a set period. If you plan to use a conventional loan to help you buy a home, you’ll need to make a down payment. If you’re a first-time homebuyer or haven’t owned property within the last 3 years, you can make a down payment as low as 3%. If you have owned property within the last 3 years, you’ll need to make at least 5% down payment. However, if your down payment is less than 20% you’ll likely need to pay for private mortgage insurance (PMI).
Your bank or lender will show you the interest rate and the types of mortgages you qualify for when you apply for a conventional loan, based on your unique financial situation. Naturally, you would select the mortgage that works with your long-term financial goals and has a monthly mortgage payment that you’re comfortable with.
This mortgage calculator will show you how interest rates, home costs, and down payments affect your monthly mortgage payment.
Pros and cons of conventional loans
- You have more choices in mortgages Conventional mortgages either come with fixed-interest rates for the full term of the loan, or Adjustable-rate mortgages (ARMs) which have an initial low fixed-interest rate and once the initial period is over, the interest rate will adjust every 6 months. Fixed-interest rate mortgages commonly come with 15-, 20-, and 30-year loan terms. This means your interest rate will remain the same for the length of the mortgage, and you’ll have to pay off the mortgage over the agreed-upon time. Adjustable-rate mortgages (ARMs) have an initial low fixed-interest rate during the introductory period of the loan. Once this introductory period is over, the interest rate will adjust every 6 months.
Fund fact: Your credit score impacts the interest rate lenders will offer you.
- You have more control over mortgage insurance If you have to pay PMI, your PMI payments will automatically stop once your home equity reaches 22%. Home equity is the difference between the amount you owe on a property and the property’s current market value. To save even more on PMI payments, when your home equity reaches 20%, you can ask your lender to remove PMI from your mortgage fees. In contrast, If you get an FHA loan and make a down payment of less than 20%, you would be required to pay a mortgage insurance premium (MIP) for the entire length of your loan.
- You can borrow more money If your credit score is over 700 and you meet the other jumbo loan qualifying criteria, you can borrow up to $1.5M. If your credit score is above 740 and you meet the other jumbo loan qualifying criteria, you can borrow up to $3M.
- Your credit score is below 620. The eligibility requirements for conventional loans are more stringent than government-backed loans. Conforming loans are sold to Fannie Mae or Freddie Mac soon after being created to help keep mortgages affordable for homebuyers. Once a Fannie or Freddie buys a loan, the lender can use the money from the sale to fund more mortgages. While this is for the greater good of all homebuyers, on an individual level, if your credit score is low, you may find it challenging to qualify for a conventional loan.
- You have a high debt-to-income ratio (DTI). Debt-to-income ratio is the difference between your gross monthly income and the total amount you need to pay toward debt each month. If you spent half your monthly income on bills and debt, your DTI would be 50%. Many mortgage lenders will not approve a conventional mortgage for homebuyers with a DTI higher than 43%. On the other hand, FHA loans can be approved for homebuyers with DTIs up to 50%.
Fund Fact: Homebuyers with DTIs up to 50% may also be eligible for a conventional loan with Better Mortgage.
- You have had past bankruptcies and foreclosures. The eligibility criteria for government-backed mortgages are more relaxed. As a result, past bankruptcies and foreclosures are forgiven much faster. Homebuyers with recent bankruptcies or foreclosures which would otherwise be approved may need to wait longer before a lender approves them for a conventional loan. And in some cases, the homebuyers loan may not be approved at all.
FHA Loan vs. Conventional Loans (Mortgage): The Pros and Cons Before You Choose | NerdWallet
FAQ
What is the downside of a conventional loan?
What are the benefits of conventional loans?
What makes a conventional loan better than FHA?
Who should use a conventional loan?
Are conventional loans better than FHA loans?
However, in general, conventional loans have stricter credit requirements than government-backed loans like Federal Housing Administration (FHA) loans. As with any type of mortgage loan, you’ll need to meet certain qualification requirements if you want to buy a home with a conventional loan.
What is a conventional loan?
A **conventional loan** is a mortgage that **isn’t insured or guaranteed by the government**.Instead, it’s issued by a private lender, such as a bank, credit union, or other financial institution.These
What is a conventional mortgage?
A conventional loan is the most popular type of mortgage in the United States. In fact, conventional loans accounted for roughly 80% of the home loans that closed in August 2021, according to Ellie Mae. Backed by private lenders rather than the federal government, conventional loans can be used to buy or refinance homes.
Are conventional loans a good choice?
Many conventional loans conform to government-set loan limits as well as income and credit score minimums. Conventional loans often cost less than government-backed mortgages such as FHA loans, but qualification requirements are more difficult to satisfy.