What Is A Conventional Home Loan?
Buying a home is an exciting process. More than 64% of Americans own their own home, and that number is on the rise as millennials enter the housing market.
Nothing compares to scrolling through listings until you find the one with the perfect raised garden beds and hardwood floors. When you schedule a walk-through with the realtor, you might find even more personalized touches that fit right into your life—like an already-installed doggy door. Then comes the less fun part: figuring out how to actually finance your home purchase.
For most of us, financing a new home means taking out a mortgage, because we don’t have the cash on hand to buy property outright. A mortgage is a loan for the part of the house cost that isn’t covered with your down payment.
For example, if you’re looking to buy a $300,000 house and you put down a $60,000 downpayment, you would take out a mortgage to cover the remaining $240,000. You pay off the mortgage over a term of 15 or 30 years, typically, depending on the type of home loan you choose.
The most common mortgages, accounting for more than 61% of home loans , are 30-year conventional mortgages with a fixed interest rate.
While these 30-year, fixed-rate conventional mortgages are a great fit for many, conventional loan requirements vary, and you may find that a government-sponsored loan is a better fit. Let’s take a closer look at conventional loan requirements, and the difference between FHA and conventional loans.
Conventional Mortgages Explained
There are several different types of mortgage loans available, from conventional mortgages to FHA loans. FHA loans are loans that are insured by the Federal Housing Administration.
Although there are other types of government insured or guaranteed loans, FHA loans are more commonly used than VA loans (for veterans) or USDA loans (rural housing). Conventional mortgages are the most common type of home loan.
Taking out a conventional mortgage means that you are making an agreement with a lender to pay them back what you borrowed, with interest. And unlike with an FHA loan, the government does not offer any assurances to the lender that you will pay back that loan.
That’s why lenders look at things like your credit score and the amount you’re willing to put down when deciding whether to offer you a conventional mortgage, and at what rate.
There are Two Main Types of Conventional Loans:
Conventional Loans with a Fixed Interest Rate
A conventional loan with a fixed interest rate means the interest rate won’t change over the life of the loan. These types of loans are also called “fully amortized conventional loans.” With these fixed-rate conventional loans, your monthly principal and interest payment will stay the same each month, which means that you know what to expect as you pay off your mortgage.
Although fixed-rate loans can give you predictability and stability when it comes to your payments, they may initially have higher interest rates than adjustable-rate mortgages. Fixed-rate conventional loans can be a great option for homebuyers because you can lock in an interest rate now, and it won’t rise, even when you’re making your final payment 30 years from now.
Conventional Loans with an Adjustable Rate
Unlike fixed-rate conventional mortgages, adjustable-rate mortgages (ARMs) have interest rates that vary over time. A conventional mortgage with an adjustable rate will have the same interest rate for a set period of time—usually three to seven years—and then the interest rate will adjust annually for the rest of the loan term. The major upside to choosing an adjustable-rate mortgage is that you may be able to secure a better interest rate now.
An ARM may be a good option if you’re not planning on staying in the home long term The downside, of course, is that your interest rate is likely to change, and could end up higher than you want it. Most adjustable-rate conventional mortgages have limits on how much the interest rate can increase over time. These limits (or caps) protect you from facing an unexpectedly steep rate hike.
Conventional Home Loan Requirements
Conventional loan requirements vary by lender, but almost all conventional loan providers will require you to have a cash down payment, a good credit score, and sufficient income to pay the monthly mortgage costs.
Many lenders who offer conventional loans require that you have enough cash to make a downpayment of 10% to 20% of the total purchase price of the house. You’ll also need to demonstrate a good credit history.
For example, you’ll want to show that you make your student loan debt payments on time every month. Each conventional loan lender sets their own requirements when it comes to credit scores, but generally, the higher your credit score, the easier it will be to secure a conventional mortgage at a competitive interest rate.
Finally, most conventional loans require you to show that you have a sufficient monthly income to meet the mortgage payments. Lenders want to minimize the risk that you stop making payments on your loan, which means that most conventional loan providers require you to provide proof of income.
What is the Difference Between an FHA Loan and a Conventional Loan?
One of the main differences between an FHA loan and a conventional loan is that conventional loans are not insured by an agency of the federal government.
FHA loans on the other hand, are mortgages that are insured by the Federal Housing Administration. This insurance means the lenders take on less risk, because if the borrower defaults, the FHA will help the lender recoup some of the lost costs.
FHA loans are geared toward lower and middle-income home buyers and require at least 3.5% down. Additionally, the loans are limited to a certain amount of money, depending on the geographic location of the house you’re buying. Of course, don’t forget that the lender administering the FHA loan can impose their own requirements as well.
The federal government also guarantees loans for military veterans through the Veterans Administration (VA). Like FHA loans, VA loans are administered by private lenders, but the VA provides certain guarantees to the lender if the veteran borrower defaults. The main benefit of VA loans is that veterans can often buy a home without having to put any cash down.
FHA and VA loans can be good options for some eligible buyers, but they can also come with higher interest rates than a conventional loan.
They also might require more paperwork and a longer approval process. If you’re ready to make your dream house a reality, make sure to carefully consider all of the mortgage options that may be available to you. It will be worth it when you finally turn the key in your new front door.