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Jun 2017

What Is a Conventional Loan?

Something first-time homebuyers don’t always realize is how many types of home loans are available to them. Every homebuyer has different needs with unique circumstances, which makes it important to choose the right mortgage for, what is quite possibly, the biggest investment of your life. One of those loan types is the Conventional loan. You’ve likely heard the name, but here’s the breakdown to help you decide if you should consider one.

So what's a conventional loan?

Every year the Federal Housing Finance Agency sets conforming limits that specify the maximum loan amount that Fannie Mae and Freddie Mac are willing to purchase on the secondary market. This means, the FHFA guidelines outline how much can be borrowed by each homebuyer. Conforming loans are those that conform to Fannie Mae’s and Freddie Mac’s guidelines and limits, while non-conforming loans are those that, simply put, don’t conform to these guidelines.

Conventional loans are those that do conform to FHFA guidelines and have different programs like the 97% LTV Conventional loan.

They typically aren’t government-insured unlike non-conforming loans, such as VA, USDA, and FHA, which have different qualifying criteria, terms, and conditions than conventional loans. In the past, conventional loans required that all homebuyers have great credit and at least 20% to put down on a house. Over the years Fannie and Freddie have lightened up on these requirements, since buying a home has become more common at a younger age. And at a younger age, the likelihood of you having 20% saved up from your few years of working isn’t very high, yet you may be very reliable and can pay off your mortgage without a problem. This created some issues for those homebuyers trying to enter the housing market for the first time. Now, with an option like the 97% LTV loan, buying a home has become more realistic for those homebuyers.

The 97% LTV (loan-to-value) conventional loan is a mortgage option that allows as little as 3% down on your home if eligible.

It’s a great conforming competitor to the government-sponsored option, an FHA loan, and can be a good option if you meet certain criteria such as:

  • You’re borrowing less than $435,100

  • You’re choosing a fixed-rate mortgage

  • You’re buying a one-unit single family home, or condo

  • If at least one borrower hasn’t owned a home in the previous three years

  • The home is your primary residence

Just for comparison, a type of non-conforming loan is the jumbo loan; a mortgage that has a higher amount to be borrowed than the conforming limit that’s been set by FHFA. The name kind of says it all — they’re bigger loans. Other non-conforming loans include government-insured loans such as VA, FHA, and USDA (as mentioned previously).

In general, conventional loans are pretty common, even though they typically require good credit.

For first-time homebuyers, this may come as a surprise since the younger you are, the less likely you have enough of a high enough credit score — at least that’s what may be assumed. A 20% down payment is still required if you want to avoid paying private mortgage insurance (PMI). So, although it’s possible to put less than 20% down, at least 5% down is typically required (excluding the 97% LTV Conventional loan.) PMI is risk-based. So, if you have good credit, you’re in a better position with your PMI cost (lower premiums) than if you had a lower credit score. Of course this also depends on who the insurance provider is. Nonetheless, it’s something to keep top of mind when considering buying a home.

What makes a conventional loan a good option?

Conventional loans are a great option for a number of reasons. Because they’re ideal for those who have great credit and a decent amount to put down on a house, they often provide a better interest rate. Along with great rates, they also boast lower closing costs and flexible payment options. Some additional benefits that come with a conventional loan include:

  • Availability as a fixed or adjustable-rate mortgage, depending on loan

  • Varieties of home types accepted

  • As low as 3% down payment requirement with income limits

  • Gift funds are accepted for a down payment if your credit score is 660 and above

Get with your mortgage banker to see if and what conventional loan may be the right choice for you.