Conventional loans are one of the most common mortgage options for financing a home. These loans are not guaranteed by the federal government, but conform to guidelines set forth by Fannie Mae and Freddie Mac. Conventional loans tend to have stricter down payment and credit requirements than other loan options.
Eligibility standards vary by lender, but generally, borrowers can expect the following in order to qualify for a conventional loan:
For most income scenarios, Neighbors Bank will require copies of recent pay stubs, at least two months of bank statements, two years of federal tax returns if you have self-employment or rental income, and savings and retirement account statements. Additional documents may be required.
Buying a home is likely one of the biggest financial decisions you’ll make in your lifetime. With so many mortgage options out there, it can get overwhelming trying to determine which type of loan is right for you. Conventional loans are the most popular loan type that homebuyers utilize. If you’re wondering what sets conventional loans apart and why they may be a good fit learning the key benefits can help you decide if this common mortgage product should be on your short list.
What is a Conventional Loan?
First let’s start with a quick refresher on what exactly a conventional loan is. A conventional loan is a mortgage that is not backed by the government. Instead, it is issued entirely through private lenders such as banks credit unions, and mortgage companies.
Conventional loans come in two main forms:
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Fixed-rate mortgages – Your interest rate never changes for the life of the loan. Your monthly principal and interest payment stays the same.
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Adjustable-rate mortgages (ARMs) – You have a fixed rate for the first 3-10 years, then the rate adjusts periodically based on market conditions.
Within the category of conventional loans, there are conforming loans (which meet loan limits set by Fannie Mae and Freddie Mac) as well as non-conforming jumbo loans that exceed those limits.
Now let’s get into the central benefits you can enjoy by choosing a conventional loan for your home purchase.
1. More Options
Conventional loans offer more flexibility than government-backed mortgages such as FHA, VA, and USDA loans. Here are some of the options at your disposal with a conventional loan:
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Loan terms – Most conventional loans come in 15 or 30-year terms. But some lenders offer alternative terms like 20, 25, or 40 years.
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ARMs – You can get an adjustable-rate mortgage, something not available with standard government loans.
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Renovation financing – Conventional loans can be used for renovation projects along with buying.
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Investment properties – Conventional loans can finance investment and rental properties, unlike most government loans limited to primary residences.
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Second homes/vacation properties – A second home mortgage is easy to get with a conventional loan.
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Cash-out refinancing – Conventional loans allow you to tap home equity through cash-out refinancing.
2. Higher Loan Limits
In 2023, the baseline conforming loan limit for most areas set by the FHFA is $726,200. But certain high-cost areas can go up to $1,089,300. On top of that, you can get a non-conforming jumbo loan for an even higher amount. So if you need a substantial mortgage for a luxury home, conventional is the way to go.
3. Flexible Interest Rates
As noted already, conventional loans can be fixed-rate or adjustable-rate. Even if you want the stability of fixed-rate, you may still benefit from some flexibility. That’s because conventional fixed-rates fluctuate daily based on market conditions. So you can lock in a low rate when they dip. Rates on government loans don’t fluctuate as much day-to-day.
4. Lower Mortgage Insurance Payments, or None at All
With a conventional loan, you can usually cancel private mortgage insurance once you build up 20% home equity. On FHA loans, you’re stuck paying mortgage insurance for the entire loan term. Conventional loan insurance payments along the way also tend to be cheaper than FHA’s upfront and annual premiums.
5. Low Down Payment
You can often get a conventional loan with just 3-5% down if you have good credit and income. While government loans allow 0-3.5% down, they have more constraints around credit requirements that may disqualify borrowers who could still get a conventional loan.
6. Access to Your Loan Amount Faster
The closing process on a conventional loan is quicker since there are no extra requirements or waiting periods involved like with VA or USDA loans. This allows you to access your loan funds promptly to secure your dream home.
7. Slightly Higher Interest Rates
Government loans do come with an advantage of marginally lower rates, since they are insured by government agencies. On average, conventional rates are only 0.125% to 0.25% higher. However, many borrowers are willing to take the trade-off of a barely higher rate for the range of benefits you get with a conventional mortgage.
8. May Require Mortgage Insurance
As mentioned earlier, you will need to pay private mortgage insurance if you put down less than 20% with a conventional loan. This does add to your monthly costs. But it’s usually not a huge difference, and you have the option to cancel PMI when you hit the right equity threshold.
Should You Choose a Conventional Mortgage?
Now that you understand the main perks of opting for a conventional loan, how do you know if it’s the right product for your home buying needs?
Here are a few key questions to ask yourself:
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What is your credit score? Conventional loans generally require a minimum score of 620. If your score is below 600, a government-backed loan may be your only option.
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How large of a loan do you need? For high-cost areas or luxury homes, you can get a higher loan amount with a conventional mortgage.
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How much can you put down? Conventional loans allow down payments as low as 3%, but if you can only do 0-3.5% down, an FHA or USDA loan may make more sense.
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Do you value flexibility? The array of options for loan terms, property types, and interest rates are a major advantage of conventional loans.
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How soon do you need to close? Conventional loans can close faster than government loans that require extra red tape.
You don’t necessarily need perfect credit or a large down payment to qualify for a conventional loan. Even with just fair credit or 5% down, a conventional mortgage can provide an easier path to homeownership than you may think.
As you consider your choices, discuss your specific situation and goals with a loan officer. They can provide tailored guidance on whether a conventional loan is right for you or if you fit the profile for a different mortgage product.
Whichever route you take, understanding the conventional loan’s unique benefits equips you to make a well-informed decision as you embark on buying your first or next home. Doing diligent research now can pay big dividends for years into the future.
4 Things Homebuyers Should Know About Conventional Loans
If you’re considering a conventional loan for your upcoming home purchase, there are four things you’ll want to keep in mind as you are applying for your mortgage:
- Down payments typically start at 5 percent. Although 3 percent is allowed for some qualifying borrowers, it may mean higher interest rates and more spent on private mortgage insurance over the long term.
- You can cancel private mortgage insurance later on. If you put down less than 20 percent, your lender will most likely require private mortgage insurance (PMI) until you have at least 20 percent equity in the property. When this occurs, you may be able to cancel PMI with your lender. This is a key differentiator with conventional loans, as many FHA loans don’t allow borrowers to cancel their mortgage insurance at any point.
- There are no up-front mortgage insurance fees. With FHA loans, you’re required to pay both an up-front mortgage insurance premium and an annual one. Conventional loans do not require an up-front payment on your PMI.
- The qualifying guidelines may be stricter. Conventional loans are not backed by a government agency, which means credit and income standards may be more strict compared to government backed options.
Though conventional loans do have more strict eligibility requirements, borrowers with lower credit scores and a minimal down payment can still qualify. Talk with a Neighbors Bank home loan specialist to determine your eligibility.
Pros and Cons of Conventional Loans
One of the biggest benefits of a conventional loan is that it comes with higher limits than other mortgage options. Conforming conventional loans go up to $484,350 in most areas, while nonconforming loans — also called “jumbo” loans — go much higher.
Other benefits of a conventional loan typically include:
- Competitive interest rates for those with good credit
- Can be used for second homes and investment properties
- High loan limits
- No PMI once you reach 80% LTV
The downside of conventional loans is that they typically have stricter credit and income requirements and also:
- Typically require a 5 to 20 percent down payment
- Will require private mortgage insurance if you can’t put down 20 percent
THE BENEFITS OF A CONVENTIONAL MORTGAGE | PROS & CONS
FAQ
What is the downside of a conventional loan?
Why is conventional better than FHA?
Who should use a conventional loan?
Why would someone only accept a conventional loan?
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.
What is a conventional loan?
Here’s an explanation for Conventional loans are mortgages that aren’t guaranteed or insured by the government — they are available through and backed by private lenders. Conforming conventional loans (the most common conventional loan type) have guidelines set by the Federal Housing Finance Agency (FHFA).
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.
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.