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Conventional Loan Basics
Conventional mortgages are the most common type of home financing. These home loans don’t come with any kind of government backing, like an FHA loan or a VA loan, and they typically meet guidelines and conditions set by the government-sponsored enterprises Fannie Mae and Freddie Mac.
Credit requirements and financial standards for conventional loans are often more restrictive. But borrowers with excellent credit and solid assets can often tap into great rates and terms on conventional loans.
Here’s a closer look at conventional financing:
Most conventional lenders require a minimum 5 percent down payment, although some may go as low as 3 percent. On a $200,000 loan, that would be either a $10,000 down payment or a $6,000 down payment. But to qualify for the best terms, borrowers may need to put down 20 percent of the loan amount (which would be $40,000 on our example $200,000 loan). Even just the 5 percent down payment can be tough for a lot of veterans and service members, especially first-time buyers.
Conventional borrowers can put verified gift funds toward a down payment or closing costs with some restrictions. Typically, borrowers with a loan-to-value ratio greater than 80 percent need to have at least 5 percent of their own money invested in the transaction.
Private Mortgage Insurance (PMI)
With most conventional loans, putting down less than 20 percent means you’re likely paying private mortgage insurance. The fee for PMI is based on your credit, your loan size and other factors. It’s added to your monthly payment and is typically required until you build up 20 percent equity in your home. PMI fees can run anywhere from $80 to $100 or more each month. Some lenders may offer lender-paid mortgage insurance. In these scenarios, the borrower takes a higher interest rate in return for the lender paying the mortgage insurance costs upfront in a lump sum. The tradeoff here is you get a higher interest rate for the life of your loan.
Conventional loans usually feature stricter credit standards than government-backed loans. Each lender is different, but many require a credit score in the mid-to-upper 600s to pursue financing. That requirement alone can make it difficult to qualify for many potential borrowers. Buyers will often need more like a 740 FICO score to tap into the best rates and terms on conventional loans. Consumers who’ve experienced a bankruptcy or foreclosure may have to wait longer to be eligible for a conventional loan than they would for a government-backed mortgage.
Borrowers with solid credit scores can often capitalize on competitive rates and terms with conventional loans. Average interest rates actually tend to run a little lower with government-backed mortgages. But homebuyers with higher credit scores may be able to tap into lower rates with conventional loans.
Conventional buyers are limited in how much they can ask a seller to pay toward closing costs and concessions. Buyers with a loan-to-value ratio greater than 90 percent can ask a seller to contribute 3 percent of the purchase price. You can ask for up to 6 percent if your loan-to-value-ratio is 75 to 90 percent. Buyers with a loan-to-value ratio less than 75 percent can seek 9 percent in seller contributions. You can also use verified gift funds from a family member, friend or other source outside the transaction to cover these costs.
Unlike with VA loans, qualified buyers can use a conventional loan to purchase a second home or a purely investment property. Buyers looking for non-owner-occupied properties may encounter higher down payment and credit requirements.
Most conventional loans are not assumable.
Availability and Options
Conventional loans are available at most banks and lenders, which can make it easier to compare rates and terms. Not every lender provides FHA, VA or USDA loans. Borrowers may also find more financing options with conventional mortgages.
To be sure, VA loans aren’t the right fit for every veteran. If you have excellent credit and the ability to put down at least 20 percent, you’d absolutely want to compare rates, terms and costs between VA and conventional financing. But that financial picture isn’t the norm for many service members, veterans and military families.
Those tougher credit and cash requirements are a big reason why VA loans are more popular than ever.