Conventional Mortgage Loans

Key Takeaways:

  • A conventional mortgage is a home loan that is not offered or secured by a government entity.
  • These loans are available through a private lender or the two GSEs – Fannie Mae and Freddie Mac.
  • Conventional mortgage rates tend to be higher than those of government-backed mortgages, such as FHA loans.

A conventional mortgage or conventional loan is a type of home buyer’s loan that is not secured or offered by a government entity.

Instead, traditional mortgage loans are available from private lenders such as banks, credit unions, and mortgage companies.

Conventional mortgage rates are typically better. (This doesn’t seem to fit and unless the linked site is affiliated seems out of place. Also, other mortgage types have better rates like VA or ARMs).

Traditional mortgage loans usually have a fixed interest rate, which means that the interest rate does not change throughout the loan period.

Conventional mortgages are not guaranteed by the federal government. Therefore, banks and creditors typically have stricter lending requirements.

Some government agencies that provide bank mortgages include the Federal Housing Administration (FHA), the US Department of Veterans Affairs (VA), and the USDA Rural Housing Service.

However, there are requirements that borrowers must meet to qualify for these programs.

About Freddie Mac and Fannie Mae

Two government-sponsored enterprises (GSEs) guarantee some mortgages:

  • The Federal Home Loan Mortgage Corporation (Freddie Mac)
  • The Federal National Mortgage Association (Fannie Mae)

Freddie Mac and Fannie Mae buy mortgages from lenders and then resell them to investors. In short, their job is to make mortgages widely available.

Freddie Mac has provided more than $11.6 trillion in home loans for more than 80 million customers. Founded in 1938, Fannie Mae introduced the 30-year, fixed-rate mortgage loan in the 1950s.

There are caveats to conventional loans that the GSEs may purchase such as “jumbo” loans. These are mortgage loans that are larger than the loan limits set by the agencies and are considered to be “non-conforming”.

Still, jumbo loans are considered conventional mortgages despite being non-conforming.

Note: The baseline conforming loan limit for 2022 is $726,200.

In some US properties, conforming loan limits are currently higher than $548,250 which covers most people currently in the market seeking loans.

In some US properties conforming loan limits are currently higher than $726,200 and the high-cost limit areas cover most people currently in the market seeking loans in these locations.

Conventional Loans come with several perks and some misconceptions that do need clarifying.

How a Conventional Mortgage Works

Over the years, lenders have tightened the qualifications for traditional home loans, but the basic requirements have stayed the same.

Prospective borrowers must complete an official mortgage application (and usually pay an application fee) and then provide the lender with the necessary documents to conduct a thorough background check, credit history, and current credit assessment.

Requirements for a Conventional Mortgage

Contrary to popular belief you don’t need a 20% down payment for a conventional loan. You can get approved for a conventional mortgage loan with as little as 3-5% down.

However, there are benefits that run will save you some money if you can manage to produce 20% upfront.

One of the biggest perks is that the Private Mortgage Insurance (PMI) policy is waived upon a 20% down payment.

Example: On a $100,000 loan you could typically expect to pay 0.5% to 1.2% of the entire loan amount on an annual basis for a Private Mortgage Insurance fee. Let’s say that your PMI fee was 1%. You would be spending $83.33 per month or an additional $1,000 a year on a policy that protects the lender if you are unable to pay your mortgage.

The PMI drops off once you have 22% equity in your home, but until then you’re paying for a policy that otherwise could’ve been avoided.

When applying for a conventional mortgage, you’ll need:

  • Proof of income. This can include two years of federal tax returns, a quarterly statement of assets, two years of W-2 statements, and pay stubs.
  • Assets. You’ll need to show bank statements and investment account statements to prove that you do have funds available for the down payment.
  • Employment verification. The lender may call your employer to confirm your employment and may want to contact previous employers too.
  • Documentation. Other documentation may be required such as your driver’s license, state ID card, and Social Security number to do a credit check.

Additionally, the purpose of the loan is important. Loans are typically approved under the premise that your purchase is for a specific use such as the following:

  • Planning on occupying it yourself (owner-occupied)
  • Buying a second home for yourself
  • Purchasing an investment property

The last hurdle in your way to getting approved for a conventional loan is making sure you have a credit score generally above 640.

Previous missteps like bankruptcy can cause delays of 4-6 years for applications and in cases of foreclosures 7 years.

>> has 8 ways to drive up your credit score.

The Pros

Conventional loans offer multiple benefits and are typically the most used type of home loan. Conventional loans can come in fixed rates, adjustable rates, or hybrids all with their own unique value proposition.

Wells Fargo for example has several options to choose from for conforming conventional loans, including 30 years fixed rate, 20 years fixed rate, 15 years fixed rate, 7/1 ARM, and 5/1 ARM, which all offer various APR rates.

Aside from a predictable conventional loan rate, lower APR, and the ability to avoid PMI if paying 20% down, NPS liabilities are not included in the decision-making process for loan approval.

The Non-Purchasing Spouse (NPS) is left out of the decision-making process, as opposed to government loans that include your nonpurchasing spouse’s liabilities into the debt to income ratio.

An additional benefit is lower closing costs in general.

Conventional loans have fewer requirements than other types of loans meaning the borrower can have an easier time covering origination fees, legal fees, appraisal/home inspection fees, title insurance, and escrow deposits.

The Cons

When reviewing the pros and cons of conventional mortgages it’s fairly tough to find the cons.

One is that conventional mortgages are a FICO score-driven model, meaning that a borrower’s credit score is taken into consideration for the conventional mortgage loan rates and Private Mortgage Insurance Fees.

Tip: You can find out what your credit score is here.

For borrowers with a credit score under 660, a better option may be to get approved for an FHA loan due to the interest rate savings, which could be in the thousands.

What Is a Non-Conforming Loan?

A non-conforming loan (or non-conventional loan) is one that doesn’t satisfy the requirements for purchase set forth by Freddie Mac and Fannie Mae.

Government-sponsored companies invest in mortgage loans and the Federal Housing Finance Agency sets the guidelines for the types of mortgages that they are permitted to purchase (FHFA).

A loan may not comply for one of two major reasons: either it does not meet an FHFA criterion, or it is too large to be regarded as a conforming loan.

The main types of non-conforming loans are jumbo loans and government-backed loans. Government-backed loans include:

  • VA loans
  • FHA loans
  • USDA loans

If you need a loan that is larger than the maximum loan amounts offered by Freddie Mac or Fannie Mae, you will require a jumbo loan.

The good news is that interest rates on jumbo loans are typically comparable to those on conforming conventional loans.

Jumbo loans, however, frequently have tougher eligibility requirements. To be eligible for one, you must have a higher credit score and a lower debt-to-income ratio (DTI). Various lenders have their own specific criteria for these loans.

The Bottom Line

When reviewing the Pros and Cons of Conventional Mortgages, for the average consumer with a healthy credit score of 660 and above (consumers with a 740 and above earn prime rates) conventional loans stand out the most.

This is because of the automatic PMI termination once the loan balance reaches 78% of the original value.

>> breaks down the home buying process here.

  • Important: Remember to do your due diligence and research further, talk to the professionals, and ask questions to make your home-buying experience run as smoothly and happily as possible. Good luck!

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Lorien is the Country Manager for Financer US and has a strong background in finance and digital marketing. She is a fintech enthusiast and a lover of all things digital.

Financial information reviewed byRoss Loehr - CFP®, MBA
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Last Updated: February 21, 2023

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