Understanding Conventional Loans

There aren’t quite the abundance of creative and unusual mortgage loan types available today that there were pre-2007, but nonetheless, for first-time home buyers or first-time real estate investors, there a quite enough options out there to give you a dizzy spell when you first hear of them.

We aren’t going to try to cover all the loan-types in just one short article, but we’ll give you a helpful lead for further research by mentioning the three main mortgage-types most popular today: conventional loans, FHA (Federal Housing Administration) loans, and VA loans.

But the question we’re addressing here is one every first time home buyer is going to ask, sooner or later: what is a conventional loan?

Conventional Loans: A Quick Definition

The most basic way to define “conventional loan” is this: it’s any mortgage loan that is NOT backed up by the federal government.

That stands in contrast with a host of special loan programs designed for those with low income, below average credit scores, or who fit into some special category such as veteran, rural resident, fixer-upper of foreclosed on properties, and more.

Who offers conventional loans? Banks, credit unions, and various other private lenders and institutions do. They’re the most traditional type of mortgage on the market (hence the name “conventional”), but they’re also more difficult for many to qualify for.

The lender takes on a greater risk with a conventional loan because the federal government is not backing up the loan should the borrower, in a worst-case scenarios, default. Therefore, you have to come up with a bigger down payment, have a more solid debt-to-income ratio, have average to excellent credit, and be a “good risk” overall to get approved.

There Are Two Basic Kinds of Conventional Loans

Conventional loans come in two basic varieties: conforming and nonconforming. The former conforms to the standards set up by Fannie Mae and Freddie Mac, who buy mortgages and then resell them to investors for a profit. The latter does not.

A non-conforming loan is basically an “unconventional conventional” loan, in that the lender and borrower have more freedom to negotiate their own terms. The lender will generally keep the loan in his own portfolio rather than sell it, so it’s up to him how flexible he wants to be. What we’ve just described is a “portfolio non-conforming loan.”

Two other types of non-conforming loan need to be mentioned. First, a “jumbo” loan fails to conform simply in that it is for a larger amount than Freddie Mac/Fannie Mae would have allowed. Secondly, a “subprime” conventional loan is given out to those with poor credit or who otherwise wouldn’t normally have qualified for a conventional loan.

Non-conforming loans are harder to re-sell, so they’re harder to get approved for many times too. But it happens, of course, and their more flexible terms often work out well for some borrowers.

Why Would You Want a Conventional Loan?

There are several reasons why those who qualify for conventional loans often do best to choose them.

First, if you provide a 20% down payment, you don’t have to buy any mortgage insurance. That saves you quite a bit in monthly house payments over the long haul. You can put down as little as 3% with conventional loans, but putting down more has its benefits.

Second, you can typically get a better interest rate based on your good credit score with conventional loans.

Third, you can get approved for loans in larger amounts with most conventional loans than with many FHA or VA loans. It all depends on the details, but as a rule of thumb, you can get a bigger loan.

Anyone who even thinks he or she might qualify for a conventional loan and is looking into purchasing a mortgage soon, should definitely explore this option very thoroughly before passing it up. It’s frequently your best overall deal on a home loan.

This article does not necessarily reflect the opinions of the editors or management of EconoTimes.