Dictionary.com defines conventional as “ordinary rather than different or original.” What does that say about conventional loans? While it may not be the most flattering description, it’s arguably an accurate one in the sense that the decision to use a conventional loan is certainly a common one. In fact, this time-tested form of financing accounted for 76.9 percent of all new home sales in 2018’s final quarter, according to the National Association of Home Builders. What is a conventional loan?
What Is a Conventional Loan?
As The Simple Dollar explains, the defining feature of a conventional loan is what it’s not: A conventional loan is not guaranteed or insured by a government agency. VA loans have the backing of the U.S. Department of Veterans Affairs, the Federal Housing Administration backs FHA loans, and USDA loans are backed by the U.S. Department of Agriculture. Participating lenders who extend loans that meet the programs’ requirements are promised reimbursement from the appropriate agency if a borrower defaults. Conventional loans don’t come with that kind of guarantee. Instead, they are issued by private lenders according to their own standards and at their own risk.
Advantages of a Conventional Loan
What makes a conventional loan such an unfailingly popular pick among homebuyers? As Dave Ramsey notes, this form of financing offers several notable advantages:
- Flexibility: Because lenders are able to set their own rules, conventional loans come in all shapes and sizes. Borrowers can choose between fixed-rate and adjustable-rate loans and find a variety of term lengths. While 15- and 30- year are probably the most popular options, terms ranging from 10 years to 40 years are available.
- Opportunities: Using a government-backed loan program means accepting its requirements, and many of these programs set limits on the type of property that you can buy. In some cases, that means only purchasing a home to serve as your primary residence. In others, the property itself must meet certain requirements. With conventional loans, you decide what kind of property you want to invest in, how you intend to use it, and what standards are acceptable. As long as you’re approved by a lender, you can shape your own opportunity.
- Convenience: Conventional loans tend to come with quicker processing.
- Competitive Interest Rates: With conventional loans, your interest rate is tied to your creditworthiness. If you’re a good risk, lenders will be willing to compete for your business by offering competitive interest rates.
- Down Payment Possibilities: The 20-percent down payment requirement is a myth. You can get a conventional loan with a down payment of just 3 percent; however, that usually means that you will be required to get private mortgage insurance.
Disadvantages of a Conventional Loan
Why doesn’t everyone rush to use a conventional loan if they offer so many advantages? As Experian indicates, conventional loans do have a few disadvantages that potential borrowers need to weigh carefully:
- Credit Score Requirements: With conventional loans, lenders assume the bulk of the risk, so borrowers need strong credit scores to qualify. While it’s possible to get certain government-backed loans with credit scores as low as 500, you’ll generally need a score of at least 620 to snag a conventional loan.
- Inflexible Qualifications: Many government-backed loan programs were designed to promote homeownership, so their underwriting requirements have a little wiggle room. That’s absent when you’re dealing with conventional loans. The requirements are generally tighter and lenders adhere to them more strictly.
- Mortgage Insurance: If you take out a conventional loan and make a down payment of less than 20 percent, you’ll probably need to pay for mortgage insurance. Of course, mortgage insurance isn’t only a factor in conventional loans. FHA and USDA loans require their own versions of this insurance. However, VA loans don’t.
What is a conventional loan? How does it compare to other loan options? Which mortgage best fits your unique situation? At PrimeLending of Wichita, Kansas, we thrive on providing clear, expert guidance and fast service to help people achieve their housing goals. Contact us today to get started.