What is a Conventional Loan?
There are two major sources for home loans in the United States. FHA loans which are insured by the Federal Government and Conventional loans which are made by private banks and overseen by the Federal government. On a much smaller scale are VA, Subprime and a host of other small types of mortgages, but FHA and Conventional make up the vast majority of loans in the U.S.
To learn more about FHA loans, see our blog on that topic, this article will deal exclusively with Conventional loans.
Set Underwriting Standards
Conventional loans are loans which adhere to the underwriting standards periodically put forth by Fannie Mae and Freddie Mac. Fannie Mae, whose initials are actually FNMA which stand for ‘Federal National Mortgage Association’ and Freddie Mac whose initials are FHLMC (if you don’t see how that spells ‘Freddie’ you’re in good company) and stands for “Federal Home Loan Mortgage Corporation” are both what the Government refers to as “Government Sponsored Entities or GSE’s. What that means is that Fannie Mae and Freddie Mac are part private business and part public, government-owned entities.
They have several functions in the US housing market but perhaps the most important job they have is to create the underwriting standards that all lenders who create Conventional loans must adhere. This creates a huge advantage to American homeowners because it allows for all Conventional loans to be underwritten in the same way and therefore guaranteed by the government. It makes banks willing to lend, investors willing to buy loans and, ultimately home loans easy to obtain.
Offered by Private Banks
Since Conventional Loans are made by private banks, they tend to be a little more sensitive to credit score when determining the interest rate. The lowest Conventional rate at any given time is typically reserved for the highest credit scores. As scores drop, Conventional rates rise to account for the greater perceived risk. For borrowers with a lower score, it is typically advisable to consider FHA financing instead since FHA is less sensitive to credit lower credit scores.
Can have Low Down Payments
Conventional loans require only 3% as the minimum down payment as of this writing and tend to allow for the lowest mortgage insurance premiums for borrowers who put down less than 20%. In cases where borrowers have 20% or more of the purchase price as available down payment, Conventional loans don’t require Mortgage Insurance at all.
For this reason, Conventional loans tend to be used by borrowers whose qualifications are a little stronger than the average. If you are a borrower who has strong credit and at least 3% of the purchase price available as down payment, a Conventional loan is likely to offer you the lowest possible monthly payment for your loan.
Typically, Conventional loans also have higher loan size limits than FHA loans as well so for those purchasing homes with higher price tags; Conventional is usually a better solution.
The only way to be sure of whether Conventional or FHA lending is better for your situation, spend some time talking with a good mortgage lender who can help you understand what is right for you.
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