Conventional Loans

What is a conventional loan?

Conventional mortgages are institutional mortgages that are not insured by the FHA (Federal Housing Administration) or guaranteed by the VA (Veterans Administration). FHA and VA mortgages are sometimes informally referred to as “government loans.” In other words, conventional mortgages make up most loans other than government loans. Conventional mortgages include conforming loans, but they also include jumbo and portfolio loans.

Most commonly when someone refers to a conventional loan, they are referring to a mortgage that follows the guidelines of Fannie Mae and Freddie Mac.

Conventional loans are often the most sought after by homebuyers and home sellers alike because of their down payment flexibility, fast closes, and low rates.

Conventional vs Conforming Loans

The terms “conventional loan” and “conforming loan” are often used interchangeably, but these do not mean the same thing! Conventional is a general category of loan types that includes a variety of products, including conforming loans.

A conforming loan “conforms” to Fannie Mae (Fannie) and Freddie Mac (Freddie) underwriting guidelines and is therefore eligible for purchase by Fannie and Freddie. Fannie and Freddie are the government-sponsored entities set up to create a secondary market for mortgages (outside of banks alone). The majority of all mortgages obtained in the United States are conforming.

Conforming loans must stay within the county’s conforming loan limits set out each year. For most areas in California, the loan limits range from $647,200 to $970,800. In the Bay Area and other high-end coastal locations, the county loan limits are usually $970,800. Any loan that exceeds the county loan limit or does not conform to Fannie/Freddie guidelines would be considered conventional “non-conforming” and could include jumbo loans or portfolio products.

What are interest rates for conventional loans?

One benefit of choosing a conventional loan is that there are several options when it comes to interest rates. The most common option is the 30-year fixed-rate, appealing for its low monthly payments and predictability over the life of the loan.

Fixed-rate mortgages are also available in shorter loan terms, with a 15-year fixed-rate being a popular option. These loans will have rates 1/8% – 1/2% lower than their 30-year fixed counterparts, but carry a higher monthly payment and are more difficult to qualify for.

Conventional loans also have adjustable-rate mortgage (ARM) options that carry an initial fixed-rate during the introductory period (typically 5, 7, or 10 years). Once this period is over, the interest rate will adjust every 6 months. ARMs are popular options for jumbo financing but do not always have lower rates for conventional loans.

Pros & Cons of Conventional Loans

Pros

More Financing and Property Types

While government loans such as FHA and VA only allow for the purchase of a primary residence, conventional loans are also available for second homes and investment properties. Additionally, conventional loans will allow for larger, multi-unit properties, up to 4 units. This makes conventional loans a great option if you’re looking to expand your portfolio with an investment property or purchase a vacation home.

It is worth noting, that these different loans and property types will carry larger down payments, up to as much as 25%.

Private Mortgage Insurance

One of the biggest perks of conventional loans is the more flexible requirements surrounding mortgage insurance. With a conforming loan (following Fannie/Freddie), private mortgage insurance is required for loans with less than 20% down. The good news is that there are several ways to remove private mortgage insurance after closing on your home. Once you accrue 20% equity in your home, you can petition to have this monthly payment removed, often by ordering an appraisal to confirm the home’s value. Otherwise, mortgage insurance is automatically removed once you accrue 22% equity in your home.

For those with at least 20% down, no mortgage insurance is required, making conventional loans a great choice to help keep monthly payments as low as possible.

Low Down Payment Options Available

If you’re a first-time homebuyer or making no more than 80% of the median income in your area, you can get a conventional loan with as little as 3% down. In most cases, the minimum required down payment for a primary residence is 5%.

If you’re buying a primary residence, the entire down payment can often come in the form of gift funds from family. In some cases, all we need is a signed gift letter to use the funds!

Cons

More Stringent Credit Guidelines

While 620 is the minimum credit score required for conventional financing, with multiple “risk factors” (high debt ratios, low down payment, etc.) you may not be able to receive approval with a credit score below 700. Seasoning periods for credit events such as bankruptcies and foreclosures are also longer than with a government loan.

Lower Debt-to-Income Thresholds

The maximum allowable debt-to-income ratio for conventional financing is 49.99%. In some cases, debt ratios will need to stay under 43%. These more stringent debt ratio requirements can limit purchasing power when compared to an FHA loan which will allow debt ratios as high as 56%.

Higher Interest Rates

Conventional loans tend to have higher interest rates than government or jumbo loans. Depending on your scenario, this can make the monthly payment higher with a conventional loan versus another loan type.

Conventional Loans vs FHA Loans

The most popular options for first-time homebuyers are conventional and FHA loans. Qualifying guidelines for FHA financing tend to be more lenient when it comes to your down payment, credit, and debt-to-income ratios, but this leniency comes at the cost of mortgage insurance that cannot be removed.

Down Payment Minimums

• 3-5% with conventional financing
• 3.5% with FHA financing

Credit Score Minimums

• 620 with conventional financing
• 580 with FHA financing

Debt-to-Income (DTI) Ratio Requirements

• 49% with conventional financing
• 56% with FHA financing

Mortgage Insurance

• Private mortgage insurance (PMI) is based on factors like down payment and credit score with conventional financing. For those with a higher down payment and strong credit score, PMI can be much lower than the mortgage insurance required with FHA financing.
• FHA’s mortgage insurance is only based on down payment and loan amount. There is also a one-time, upfront premium financed into the loan with FHA financing, whereas conventional financing only consists of the monthly premium.
  • With less than 10% down, mortgage insurance will be in place for the life of the loan for FHA financing.

Conventional Loans vs VA Loans

For eligible veterans and their spouses, VA loans are an excellent choice as they allow 0% down and offer more lenient qualifying guidelines. VA loans are only eligible for primary residence purchases, and you’ll be required to pay a funding fee that would not apply with conventional financing.

Down Payment Minimums

• 3-5% with conventional financing
• 0% with VA financing

Credit Score Minimums

• 620 with conventional financing
• 580 with VA financing

Mortgage Insurance

• VA loans do not require mortgage insurance. These types of loans may require a funding fee, which varies based on down payment and whether you’ve had a VA loan in the past. The funding fee is typically financed into the loan amount.
• Eligible veterans can have the funding fee waived – your Certificate of Eligibility will let you know whether the funding fee is required.

Conventional Loans vs Non-QM Loans

Non-QM loans are great options for those who may not qualify through traditional underwriting guidelines, but carry much higher down payment requirements than conventional financing and are not always available for first-time homebuyers.

Down Payment Minimums

• 3-5% with conventional financing
• 10-30%, depending on the program for non-QM loans

Credit Score Minimums

• 620 with conventional financing
• 600-700, depending on the program for non-QM loans

Debt-to-Income (DTI) Ratio Requirements

• 49% with conventional financing
• 50% for most non-QM loans, with some flexibility

Is a conventional loan right for you?

There is no one-size-fits-all for mortgage financing. The best way to determine whether a Conventional loan makes the most sense for you is to talk to one of our mortgage experts at JVM Lending. Our experts can walk you through monthly payment scenarios, give you current interest rates, and discuss any other questions or concerns you might have.