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Mortgage

What Is a Conventional Loan?

A conventional loan is a mortgage loan that's not backed by a government agency. Conventional loans are broken down into "conforming" and "non-conforming" loans.

Conforming conventional loans follow lending rules set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). However, some lenders may offer some flexibility with non-conforming conventional loans.

How Conventional Loans Work

Conventional loans are originated and serviced by private mortgage lenders like banks, credit unions and other financial institutions, many of which also offer government-insured mortgage loans. In general, conventional loans don't have some of the same perks as government-insured loans, such as low credit score requirements and no down payment or mortgage insurance.

It's possible to get approved for a conforming conventional loan with a credit score as low as 620, although some lenders may look for a score of 660 or better. Even if you can qualify for a conventional loan, though, your interest rate will largely depend on your credit score and overall credit history. The better your credit is, the less you'll pay in interest over the life of the loan.

You can find conventional mortgage loans with a down payment requirement as low as 3%, and some lenders have special programs that offer up to 100% financing. However, if you don't put down 20% or more, the lender typically requires you to pay private mortgage insurance, which can cost between 0.3% and 1.5% of your loan amount annually.

Conventional loans typically run for 30 years, but it's possible to qualify for a 15- or 20-year conventional mortgage loan.

How Is a Conventional Loan Different From a Government-Backed Loan?

Government-insured mortgage loans have special features that can make them a good fit for certain homebuyers. Here's a quick summary of each option and who might consider it:

  • FHA loans: These loans allow you to get into a home with a credit score as low as 500 if you have a 10% down payment, or 580 if you have a 3.5% down payment. This may be a good option if your credit score isn't high enough to qualify for a conventional loan.
  • VA loans: Backed by the U.S. Department of Veterans Affairs, VA loans are designed for select members of the military community, their spouses and other beneficiaries. They don't require a down payment and don't charge private mortgage insurance.
  • USDA loans: Insured by the U.S. Department of Agriculture, these loans can help low- to moderate-income homebuyers who want to purchase a home in an eligible rural area. They don't require a down payment and provide a little more flexibility with credit score requirements.

While these loans are insured by various government agencies, it's private lenders that offer them to borrowers—the same lenders that also offer conventional loans. Beyond special programs some lenders may offer, conventional loans don't have many of the perks government-insured loans provide across the board.

If you're trying to decide between a conventional loan and a government-insured loan, the right one for you depends on your financial situation. If you have high credit scores of at least 740 and you can afford to make a 20% down payment, a conventional mortgage may offer the best interest rate and lowest fees.

Because of the strict eligibility requirements that come with VA and USDA loans, it can also be easier for many homebuyers to qualify for a conventional mortgage.

If your credit scores are currently low, however, you may find it easier to obtain an FHA-insured loan. Just keep in mind that FHA-insured loans charge their own form of mortgage insurance, called the mortgage insurance premium, that includes an upfront fee and ongoing charges that add to your mortgage cost.

Improving your credit score before you apply for a mortgage can help you qualify for a conventional mortgage and may also reduce the mortgage interest rate and fees to obtain the loan.

What Are the Types of Conventional Loans?

There are several types of conventional loans that you may come across as you compare lenders and mortgage options. Here are some of the most common ones and how they work.

Conforming Conventional Loans

Conforming conventional loans are loans that adhere to the standards set by Fannie Mae and Freddie Mac, including maximum loan amounts.

In 2019, the standard limit for a conforming conventional mortgage is $484,350 for a single-family home that you intend to live in. For borrowers in high-cost areas, the limit can be as high as $726,525.

Jumbo Conventional Loans

If you want to borrow more than the lending limits for conforming loans, you should look for lenders that specialize in jumbo mortgage loans.

Jumbo loans typically require higher credit scores than conforming loans (think 700 or higher), and you may also need to have a lower debt-to-income ratio (DTI) and put down a larger down payment.

Even with those things, you may end up with a higher interest rate than a conforming loan because the larger loan amount represents a bigger risk to the lender.

Portfolio Loans

A portfolio loan is a conventional loan that a lender chooses to keep in its own portfolio rather than selling it on the secondary market—something that's common but requires that loans meet Fannie Mae's and Freddie Mac's standards.

A portfolio loan gives lenders more flexibility with underwriting, which can be good for you if you have a low credit score or high DTI.

However, portfolio loans tend to come with higher interest rates and don't have all the same consumer protections that come with conforming loans.

Subprime Conventional Loans

Conforming loans require that you have a debt-to-income ratio below 50% and a credit score of 620 or higher. But if your credit isn't quite there, you may qualify for a subprime mortgage loan.

These loans are non-conforming and may charge high closing costs and interest rates. However, they can also provide a way to get into a home without needing to wait until your credit is in excellent shape.

Amortized Conventional Loans

These loans are fully amortized, giving homebuyers a set monthly payment from the beginning to the end of the loan repayment period, without a balloon payment. Amortized conventional loans can have fixed or adjustable mortgage rates.

Adjustable Conventional Loans

A fixed-rate mortgage loan has the same interest rate—and, therefore, the same monthly payment—throughout the life of the loan. With an adjustable-rate mortgage loan, however, you'll get a fixed interest rate for a set period, typically between three and 10 years. After that, your interest rate can adjust each year based on the current market rates.

Adjustable conventional loans typically have lower interest rates than fixed conventional loans in the beginning, but their cost can be higher overall if market mortgage rates increase over time.

What Are the Advantages of a Conventional Loan?

There's no right mortgage loan for everyone, so it's important to know both the benefits and drawbacks of each of your options before you choose. Here are some of the benefits you'll get from a conventional loan.

Low Interest Rates

Because your interest rate on a conventional loan is tied to your creditworthiness, among other factors, a high credit score can help you qualify for a low interest rate. And while a low down payment can result in you paying private mortgage insurance, you can request to have the insurance requirement removed once your loan-to-value ratio reaches 80%.

In contrast, the mortgage insurance premium that comes with an FHA loan may stay on there for the life of the loan.

Higher Loan Limits

While conforming loans do have limits, you can go even higher with jumbo conventional loans if you need to. You may not get that kind of flexibility with government-insured loans.

Flexibility

Private mortgage lenders have more flexibility with conventional loans than they do with government-insured loans, primarily because they don't need to follow the guidelines set by those government agencies.

As a result, you may have an easier time finding a conventional loan with flexible down payment options and term lengths, not to mention opportunities to get a loan if your credit doesn't meet the standards for a government-insured or conforming loan.

What Are the Downsides of a Conventional Loan?

Along with some of the benefits of getting a conventional loan over a government-backed one, there are also some disadvantages to consider.

Higher Credit Score Requirements

You typically need credit scores of at least 620 to qualify for a conforming conventional loan. In contrast, you can qualify for an FHA loan with a credit score as low as 500.

Also, USDA loans have a minimum score of 580, though it's possible to go lower if the new loan significantly reduces your housing costs, your credit circumstances are temporary and beyond your control, or the new loan provides a benefit to the government.

Higher Down Payment Requirements

FHA loans require a minimum down payment of 3.5%, which is slightly higher than the 3% minimum you can find with many conventional mortgage lenders. However, a higher down payment will be required if you want a lower interest rate and to avoid private mortgage insurance.

Stricter Qualifying Guidelines

Government-insured mortgage loans place less risk on the mortgage lender, so it may be easier to qualify for one of those, as long as you meet the agency's eligibility requirements.

With a conventional loan, on the other hand, your personal financial situation may be scrutinized more closely because the lender is taking on more risk by originating the loan.

How to Qualify for a Conventional Loan

If you've decided that a conventional loan is right for you, here's what you need to know about the process of qualifying for one.

Check Your Credit Score

Before you do anything else, it's important to know where you stand with your credit. You can do this by checking your credit score for free with Experian.

If your credit score is 620 or higher, you'll have a chance to get approved for a conforming conventional loan. And if it's in the mid- to upper-700s, that will give you a better chance of qualifying for favorable terms on your new loan.

Work on Your Credit Scores

If your credit isn't where you want it to be, start taking steps to improve your credit score. This entails paying your bills on time (and getting caught up on late payments or collection accounts), paying down credit card debt, avoiding unnecessary borrowing and more.

If you're not quite sure where to start, get a copy of your free credit report to help you pinpoint which areas need to be addressed.

Improving your credit can take time, but it can save you tens of thousands of dollars in interest over the life of a mortgage loan.

Also, note that past bankruptcy will not disqualify you from getting a conventional loan. Two years after completing a Chapter 13 repayment plan, you will be eligible to apply for a conventional mortgage. The waiting period for a Chapter 7 bankruptcy is four years after your bankruptcy has been discharged.

Get Preapproved

A mortgage preapproval is a letter from a mortgage lender, effectively agreeing to lend you up to a certain amount of money to buy a home, as long as you meet certain conditions.

It's not an official mortgage application, but it does require that you provide documentation of your current financial situation, including tax returns, pay stubs, bank and investment account statements, and more. It also includes a credit check.

It's best to get preapproved before you even start shopping for a house, and having a preapproval letter can help legitimize an offer you put down on the house you want. They typically last 60 to 90 days, so you'll have plenty of time to find a home.

Keep in mind, though, that the lender will check your financial and credit status again before officially approving your mortgage application.

Save for a Down Payment

While many conventional loans don't require a big down payment, the more money you put down, the better your chances of qualifying for a lower interest rate.

Many lenders require a down payment as low as 3%, and some may have special programs that offer up to 100% financing. But if you can manage it, try to save up enough to put down 20% or more to avoid private mortgage insurance.

Check Your Debt-to-Income Ratio

Your credit score is one factor in determining your eligibility for a conventional mortgage, but lenders will also look at your debt-to-income ratio.

Lenders typically want to see that your total monthly debts are no more than 36% of your monthly gross income. Lenders may stretch their required DTI to 43% or higher if you have very strong credit scores, large savings set aside, or are making a down payment of at least 20%. The maximum Fannie Mae and Freddie Mac will allow for conforming loans is 50%.

Next Steps

Finding a mortgage lender and submitting an application for a conventional mortgage is fairly simple, and most of the time can be done online.

Before you get preapproved, consider your budget based on how much you can afford on a monthly basis.

Then once you have a preapproval letter in hand, start the house-hunting process. And keep in mind that you're not married to the mortgage lender that provided your preapproval letter. In fact, it's a good idea to apply with multiple lenders to compare rates and terms.

When you are shopping for the best rates and submit mortgage applications at several lenders within a certain time period—typically 30 days—your FICO® Score* will roll that into one inquiry on your credit report, which avoids damaging your credit score.

The mortgage process can take a long time from start to finish, but taking each step carefully can help you get the best deal for your situation.

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