What Is a Conventional Loan for a Home?

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House with a sold signThe term “conventional loan” refers to a mortgage that is not backed by a government entity. FHA, VA, and USDA loans are guaranteed or insured by the federal government.

The conventional loan, sometimes called a conforming loan, is not federally insured. Conventional loans are provided to borrowers indirectly through the Federal Home Loan Bank or Federal National Mortgage Association (Fannie Mae). The following explains the operation of conventional loans.

Fannie Mae and Freddie Mac are publicly listed companies that buy mortgage-backed securities and resale them to investors. This allows banks and other financial institutions to lend to a wider variety of customers, since their capital is not tied to long-term debt.

Fannie Mae and Freddie Mac have strict loan purchase requirements. A conforming loan is a mortgage that conforms with the lending criteria of Freddie Mac and Fannie Mae. It is common to hear the terms conforming and conventional used interchangeably.

Fannie Mae and Freddie Mac have similar requirements for loan approval. Loans that do not comply or conform to conventional lending criteria are referred to as non-conforming loans. Non-conforming loans are often loans that exceed the lending cap set by the Federal Housing Finance Agency (FHFA).

Loan Terms

The conventional fixed rate mortgage has a loan term of 10, 15, 20, 25, and 30-years. Keep in mind that the monthly loan payment increases as the term decreases.

Does a conventional loan require mortgage insurance?

Private mortgage insurance graphicMany first-time home purchasers and homeowners seeking to refinance their current mortgage are unable to make the 20% down payment that is required by conventional financing.

Private mortgage insurance is the answer.
In exchange for a monthly payment, a private mortgage insurance company will reimburse the lender for the difference between the necessary 20% and the borrower's down payment in the case of a foreclosure (or another mortgage insurance option).

After a homeowner has built up a 22 percent equity position, private mortgage insurance is no longer needed.

FHA, VA, and USDA all demand a one-time payment of mortgage insurance at closing. The cost may be covered by the loan or paid at the time of settlement.

Veterans who get a monthly disability payment are exempt from the rule, according to the Veterans Administration. Purple Heart recipients are now exempt from paying the upfront mortgage insurance.

The initial mortgage insurance premium is not required for conventional home loans.

Fixed and Adjustable Rate Loan Options

Fixed or adjustable rate conventional mortgages are available. The benefit of a fixed rate mortgage is the predictable payment each month. The homeowners' insurance, property taxes, and other costs may increase, but the principal and interest part of the mortgage payment never changes with a fixed rate conventional mortgage.

Unlike a fixed rate mortgage, the interest rate on an adjustable rate mortgage may change depending on the loan guidelines. One, three, five, seven and ten year adjustable rate mortgages are available.

The interest rate is fixed for the initial term of the mortgage and can adjust after the introductory time period.

For example, the 5-year adjustable rate mortgage is popular with home buyers and homeowners who refinance their existing mortgage. The 5/1 ARM has a fixed rate for five years and following the 5th year (60 payments), the interest rate could possibly change based on the loan parameters.

Why would anyone take a mortgage with a variable interest rate? The reason is that the 5/1 ARM has an interest rate lower than the fixed rate, which allows the borrower to purchase a more expense house or obtain a lower monthly payment.

Conventional Loan Second Home

The government loans, FHA, VA and USDA do not finance second homes. The conventional/conforming mortgage will accommodate the purchase or refinance a second home. The down payment for a second home is only 10%.

Can I use a conventional loan to buy an investment property?

FHA, VA, and USDA lending programs do not provide investment mortgages. A conventional loan is your only choice if you're interested in purchasing a genuine investment property, that is, one that you intend to rent or sell but not live in.

Conventional loans require a down payment of 15% to 25% (depending on the kind of property being purchased), and credit score requirements are higher than those for government programs. Only one to four unit dwellings are permitted.

What are conventional loan limits?

When you apply for a mortgage, you will discover that the amount you may borrow is limited. This is decided on an individual basis by your creditworthiness and the amount of money you can afford to spend each month. The Federal Housing Finance Agency establishes the maximum loan amount (FHFA).

The conforming loan limitations apply to all conventional mortgages supplied by mortgage lenders to Fannie Mae and Freddie Mac. These are consistent with the majority of the U.S. counties, with a few exceptions for high-cost regions.

The maximum loan limit for government backed loans is 65% of the FHFA loan limit. It should be noted that USDA and VA home loans do not have an established loan limit. The maximum ceiling is determined by the lender.

Conclusion

In conclusion, a conventional loan is a loan that is not insured or guaranteed by the federal government. It is a loan that is offered by a private lender and is based on the borrower's credit score and income. A conventional loan can be used to purchase a home, refinance a mortgage, or for home improvement projects.