You know you’ll need a mortgage to buy a home. But did you know that there isn’t a one-size-fits-all home loan everyone gets when they go to make a purchase? There are many different types of home loan products, the most popular being the conventional loan. In 2017, 73.8% of new homes were funded via a conventional loan.
A “conventional loan” is a mortgage not backed by the government. This is the big difference between conventional and non-conventional loans, and conventional loans are pretty standard to what everyone thinks of when they say “mortgage.” Conventional loans can be fixed rate (where your interest rate remains the same over the life of the loan) and adjustable rate (where your interest rate changes over time).
Conventional loans don’t come with any special bells and whistles, and compared to other loan products, qualification criteria can be pretty strict. So, why choose a conventional loan? Let’s go over the benefits as well as other considerations you should take into account when deciding on a home loan type.
Why choose a conventional loan?
Conventional loans come in two flavors: conforming and nonconforming. Conforming means the loan will be sold from your lender to Fannie Mae or Freddie Mac. This happens with smaller loans as they’re easier for banks to sell.
A nonconforming loan (a.k.a. a “jumbo” loan) is a mortgage that isn’t sold to Fannie Mae or Freddie Mac because the loan is so large. A loan is considered “jumbo” or “nonconforming” when it is above the conforming loan limits of $679,650 (for select states and high-cost areas in 2018; the limit amount is subject to annual change). Note that second home or vacation home loans are also considered non-conforming, no matter the loan amount.
The main difference between “conforming” and “nonconforming” is that with a larger loan (more money from the bank) comes more scrutiny of your credit score and stricter lending requirements.
Whether you get a conforming or nonconforming loan, the biggest benefits to a conventional loan include:
- Flexible term options: you can choose to pay off the home on any timeline between eight and 30 years
- No private mortgage insurance once you reach 80% equity in the home or if you make 20% down payment
- Buyers can get into a home with as low as 3% down payment
- Higher loan amounts (buyers can borrow up to $679,650 in select areas and up to $453,100 in the rest of the United States; for up-to-date loan amount limits, check here)
- Available for any type of home: a vacation, rental, or primary residence
How do I qualify for a conventional loan?
One of the biggest “cons” for a conventional loan is the stricter lending requirements. To qualify for a conventional loan you’ll need:
- Two years solid employment history
- 2-3 months of estimated mortgage payment in savings
- A minimum 620 credit score
- A lower debt-to-income ratio; around 43% is the max
If this sounds like you, you can check conventional loan rates here.
What about a non-conventional loan?
A non-conventional loan is any loan product funded by the government. Types of non-conventional loans include:
- Federal Housing Administration (FHA) Mortgage Program for those with a low down payment
- VA Home Loan Program for veterans
- United States Department of Agriculture (USDA) Mortgage Program for mortgages in rural areas
The FHA loan vs the conventional loan
While two out of three non-conventional loan types are restricted to certain groups of people (veterans, farmers), anyone can apply for an FHA loan. Many first-time buyers like to stack up an FHA loan to a conventional loan because it has more relaxed restrictions, allowing many first-time buyers to get into their first home. With an FHA loan a potential buyer can:
- Get into a home with as little as 3.5% down
- Get into a home with a minimum credit score of 500
- Use gift money to fund 100% of the purchase
- Use down payment assistance funds to finance the purchase
The biggest differences between an FHA and conventional loans are that an FHA loan requires private mortgage insurance for the lifetime of the loan, and that the home must be used as the primary residence. Having to pay private mortgage insurance on the loan will make your monthly payments higher than if you put the standard 20% down on a conventional loan.
Also, if you live in a pricey area, the lower mortgage limits on an FHA loan may deter you from considering it as an option.
Is a conventional home loan right for me?
It depends. A conventional loan may be the best option for you if you have good credit and have a nice down payment saved. With a conventional loan you also get more flexibility: depending on how much you choose to pay in down payment, you can secure lower interest rates and avoid paying extra each month in private mortgage insurance. To decide on the right loan fit, it’s best to shop rates and play with numbers on a mortgage calculator. A mortgage calculator can help you determine the amount you’ll need, figure out your monthly payments, and find the lowest interest rate.
Start crunching numbers with LendingHome’s mortgage calculator.
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