On our site we have discussed different aspects of a mortgage including Private Mortgage Insurance (PMI), interest rates, and refinancing. One common term that is often found when discussing home loans is ‘conventional loans.’
What are conventional loans though? When applying for a mortgage, it is important to be informed so that you can make the best decision for you and your circumstances. With that in mind, this article will be defining and explaining what a conventional loan is, two different types of conventional loans, and the benefits as well as some cautions with this loan type.
What is a Conventional Loan?
When discussing mortgage loans, conventional loans are the most common. Conventional loans are loans through a private mortgage lender that is not backed by a government agency. This loan is compared to both VA and FHA loans which are through the government.
What are the Two Categories of this Loan?
The two categories of this loan are conforming and non-conforming. The distinction between the categories essentially comes down to a price point cap set each year by the Federal Housing Finance Agency or the FHFA as well as two Government Sponsored Entities: Fannie Mae and Freddie Mac.
• Conforming Conventional
According to the FHFA, in order for a mortgage loan to qualify in 2023 as conforming, the loan must be lower than $726,200 for a single unit property. This number, however, is just a baseline and can raise in higher expense areas such as San Francisco and New York City to $1,089,300 (or 150% of the baseline number).
• Non-Conforming Conventional or ‘Jumbo Loan’
Non-Conforming loans, or jumbo loans, are those that do not meet the standards stated above. Typically, these will come with a higher interest rate than conforming loans as the riskiness of these are higher in comparison to conforming loans.
To avoid a jumbo loan, an alternative is to take out two smaller loans that would both qualify as conforming.
What are the Benefits and Cautions of a Conventional Loan for my Mortgage?
• Benefits
The benefits found with conventional loans are many including generally low interest rates, fast loan processing, diverse down payment options, various term lengths on a fixed rate, and often a reduced PMI.
• Cautions
As with any loan, there are always cautions to be mindful of. With a conventional loan, however, the cautions really are established to help homeowners make better financial decisions.
• Need a down payment
With a conventional loan, buyers need a down payment of at least 3%. The saving grace of a down payment is that it forces you away from certain higher priced options that may drastically and negatively impact your finances.
• Strict approval standards
The standards for approval to a conventional loan may include levels of DTI ratio standards, credit history, loan-to-value ratio (LTV) and other documentation requirements.