How does a conventional mortgage compare to other loan types?
If you’re in the market for a mortgage, you may be able to choose between a conventional mortgage or a government-backed mortgage. Each option has its pros and cons, and each can be a solution that helps you afford a home. Let's review and discuss the key differences between conventional mortgages and other loan types.
Do you know that a conventional mortgage is right for you? Take a look at the current rates and start the application process today!
What makes a mortgage ‘Conventional’?
A conventional mortgage is an agreement between the borrower and a lender – be it a bank, a mortgage company, or some other financial institution. These mortgages, while the most common (64% of all home loans), aren’t insured by the government. They come with a higher bar of qualifications that potential homebuyers must meet. These standards are set by Fannie Mae and Freddie Mac. Fannie and Freddie are government-chartered companies that help buy mortgages from originating lenders for the secondary market.
Government-backed mortgages such as FHA Loans, VA Loans, or USDA loans are typically less strict than conventional loans. The government takes on responsibility to recoup your loan should you fail to make payments. While the qualifications for these loans are lower, origination and closing fees may be higher.
How can I qualify for a conventional mortgage loan?
Conventional lenders will look at all aspects of your ability to repay, many of which you’ll find in this section. These items are not isolated. Each aspect may have a positive or negative effect on the others.
For example, if you place a larger down payment, the lender may allow a lower minimum credit score. Also, if you have a cosigner, you may need less in cash reserves.
Here are a few of the most common qualification factors you will encounter with a conventional mortgage:
Down payment – Depending on the lender, a buyer can qualify for a conventional loan that have options for a down payment as low as 3%. If you own less than a 20% equity stake in the house, expect to pay Private Mortgage Insurance (PMI).
Credit Score – Minimum FICO scores apply.
Debt to Income Ratio (DTI) – Total non-mortgage debt (credit cards, car loans, etc.) will be less than 43% of your total income. Some lenders are more lenient than others with regards to this rule.
Income stability – The more you can show sustained income that steadily increases over time, the better you’ll look in the eyes of a lender. Most lenders look for two years of steady employment, ideally with the same company. Other income sources include self-employment, gig economy work, sizable savings accounts or investment income, or payments from a trust or inheritance.
Cash Reserves – how much do you have in the bank to cover mortgage payments and other living expenses should you experience a gap between jobs? Short-term disability insurance can also protect your mortgage payments should you get injured on the job.
What are the terms for a conventional mortgage?
Most conventional mortgages are either “fixed” or “adjustable” rate loans.
● A fixed rate loan locks in a rate for the life of the loan, typically 30, 15, or 10 years. This means your monthly payment will remain the same until your home is paid off. The consistency can bring great comfort and certainty to homebuyers. Especially when compared to renters who may face annual rent increases.
● An adjustable rate mortgage (ARM) begins as a fixed rate loan, often with a lower interest rate than a 30-year mortgage. It adjusts after a period of time to align with the market. A 7/6 ARM means that the rate will remain fixed for seven years. After seven years, the mortgage rate will adjust to the market every six months until the house is paid off or the home is refinanced. This type of loan is attractive for buyers who don’t plan on staying in their homes for 30, 20, or even 10 years.
Conventional Mortgage vs. FHA loan
An FHA Loan is insured by the Federal Housing Administration. FHA loans give first-time homebuyers and senior homeowners more options to secure a home loan. These loans also offer expanded credit guidelines. These loans are insured by the US Government. This means that the government will assume the risk should the borrower default.
There are pros and cons to consider when comparing conventional mortgages to FHA loans. Key aspects include the minimum amount needed for a home down payment, available interest rates, debt-to-income ratio, minimum credit score, work history guidelines, and loan fees and terms.
An FHA loan is typically more lenient or flexible than conventional loan standards. It's designed to open the doors of home ownership to more people. This is especially important for people who are building or rebuilding their credit scores, self-employed, freelance or gig economy workers, and children of undocumented resident aliens (DREAMers). In 2021, the FHA revised its policies to allow adult children covered by the DREAM Act (Development, Relief and Education for Alien Minors) to qualify for FHA Loans.
● Down Payment Options – as low as 3.5%
○ Parents, relatives, close friends, or an agency-sponsored homeowner assistance program may pay all or part of your down payment as a gift to the homebuyer
● Credit Score – Minimum FICO scores apply
● DTI options – 43% (total – mortgage and other debts)
Conventional Mortgage vs. VA Loan
FHA Loans are only one type of loan that you may qualify for. If you serve or have served in the Armed Forces, or are a surviving family member, you may qualify for a VA Loan. This type of loan can be used to buy, refinance, or renovate a house.
Among the many benefits of a VA Loan is the ability to get a mortgage with no down payment. This option enables Veterans and their families to move in with cash in hand to take care of repairs and other expenses. To see if you qualify for a VA Loan, review the guidelines to secure a Certificate of Eligibility (COE).
● Down payment options – 0% – though the larger your down payment, the lower your monthly payment and the more favorable other loan terms may be
● DTI options – 41% (max – mortgage and other debts) – unless you have generous cash reserves (see below)
● Credit Score – Minimum FICO scores apply
Conventional Mortgage vs. USDA Loan
The United States Department of Agriculture (USDA) has several home loan programs to help moderate to very-low income families to get housing in rural areas. USDA loans help families that work in farming and agriculture.
● Restrictions: House must be used as a primary residence (new home loan or a refinance)
● Down payment options – 0% – though the larger your down payment, the lower your monthly payment, and the more favorable other loan terms may be
● DTI options – 41% (max – with no more than 29% coming from the mortgage)
● Credit Score – Minimum FICO scores apply
● Caps – Annual income not to exceed 115% of median household income in the area
● Cash Reserves: more lenient
Conventional Loans vs. Other Government Loans
Additional government programs help Native American families, purchasers of mobile homes, families in declared disaster areas, and more. For a longer list of available options, visit the official loans site of the US Government.
Where can I get current conventional mortgage rates today?
For up to the minute data, tools, tips, and a portal to get you started, visit the our rate calculation center. See what types of loans you qualify for, calculate potential mortgage payments, and get answers with help from our agents. You can fill out your no obligation loan application in just about 15 minutes, and get pre-approved in as little as 24 hours.
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