What Is a Conventional Mortgage or Loan?
A conventional mortgage is a type of loan provided by private lenders for homebuyers. Unlike Federal Housing Administration (FHA) loans, conventional loans typically require a higher credit score for eligibility.
These mortgages are not backed by a government entity but are available through private lenders like banks, credit unions, and mortgage companies.
However, some conventional mortgages can be guaranteed by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac.
Key Takeaways
- A conventional mortgage or loan is not supported by a government entity and is offered by private lenders or GSEs like Fannie Mae and Freddie Mac.
- To apply, potential borrowers need to submit an official mortgage application, along with required documents, credit history, and current credit score.
- Conventional loan interest rates may be higher than those of government-backed mortgages such as FHA loans.
Understanding Conventional Mortgages and Loans
Conventional mortgages can have fixed or variable interest rates. These loans, not guaranteed by the federal government, typically have stricter lending requirements by banks and creditors.
While government agencies like the FHA offer mortgages with low down payments, agencies like the VA and USDA have specific requirements for borrowers to qualify for their programs.
Changes in upfront fees for Fannie Mae and Freddie Mac home loans took effect in May 2023, affecting homebuyers based on credit scores and down payments. Fannie Mae provides detailed loan guidelines on its website.
Example of Conventional Mortgage
Qualifying for a conventional mortgage, which offers an affordable way to finance property purchase, typically requires meeting strict criteria.
For instance, with a $500,000 home, a $100,000 (20%) down payment, and a credit score of 650, one could secure a conventional mortgage at a 5.50% rate, resulting in a monthly payment of around $2,271 on a 30-year loan for principal and interest.
Conventional Mortgage vs. FHA Mortgage
FHA loans aim to make homeownership accessible to low- to moderate-income borrowers with credit challenges or limited savings. In contrast, conventional loans have higher credit score and down payment requirements.
FHA loans are not directly granted by the FHA but by approved lenders. On the other hand, conventional loan eligibility hinges on a borrower’s creditworthiness and financial stability, requiring a credit score of at least 620.
Conventional loan interest rates vary based on factors like down payment size, chosen mortgage product, and prevailing market conditions.
Conventional vs. Conforming
Conventional loans, often confused with conforming mortgages, differ in that conforming loans meet Fannie Mae and Freddie Mac funding criteria, including annual dollar limits by the FHFA.
While all conforming loans are conventional, not all conventional loans qualify as conforming. For example, a loan exceeding the conforming limit is a conventional but non-conforming mortgage.
The secondary market for conventional mortgages is vast, with most loans bundled into securities traded in markets known as mortgage to be announced (TBA) and collateralized into mortgage obligations (CMOs).
Types of Conventional Mortgages
Conventional mortgages come in various types, though distinct in their terminology. The common types include conforming loans, jumbo loans, portfolio loans, subprime loans, amortized loans, and adjustable-rate loans.
Required Documentation for a Conventional Mortgage
Post the 2007 subprime crisis, lenders have imposed stricter standards, requiring potential borrowers to complete a mortgage application and submit documents like income proof, asset statements, employment verification, and other identification documents.
When assessing a borrower’s finances, lenders consider the ability to make mortgage payments alongside upfront costs like down payment, closing fees, and other related expenses.
1. Proof of Income
Income documents like pay stubs, tax returns, asset account statements, and W-2 forms are required along with any additional income proof for alimony or bonuses.
2. Assets
Bank and investment account statements are necessary to show funds for down payment, closing costs, and reserves. Gift letters are required if funds are received from relatives or friends.
3. Employment Verification
Lenders verify stable income through pay stubs for employed individuals and extensive documentation for self-employed borrowers regarding their business and income.
4. Other Documentation
Additional documentation includes a copy of identification, Social Security number, and credit report authorization for lenders to review the borrower’s financial profile.
Interest Rates for Conventional Mortgages
Conventional loan interest rates, though potentially higher than those for government-backed mortgages like FHA loans, depend on loan terms, economic conditions, and individual borrower’s financial situation.
Interest rates are influenced by factors like inflation, the demand for mortgage-backed securities, and expectations for future inflation, with points paid to the lender also affecting the interest rate.
Borrowers with strong financial profiles, including assets, creditworthiness, and a substantial down payment, may secure better interest rates on their conventional mortgages.
A key consideration for long-term homeowners is paying points upfront to reduce interest costs throughout the mortgage term.
Special Considerations for a Conventional Mortgage or Loan
Conventional mortgages are suitable for individuals with established credit and strong financial positions, offering competitive terms and rates. However, those with limited credit history or financial stability may find it challenging to qualify for these loans.
Who May Qualify
Ideal candidates for conventional mortgages have good credit scores, acceptable debt-to-income ratios, and sufficient down payment funds.
Who May Not Qualify
Individuals with recent financial setbacks, low credit scores, high DTI ratios, or inadequate down payment funds may struggle to qualify for conventional loans. Exploring alternative loan programs may be beneficial for such borrowers.
If declined for a conventional mortgage, seeking feedback and exploring options like FHA loans tailored for first-time homebuyers may provide alternative paths to homeownership.
The Bottom Line
Conventional mortgages, unlike government-backed FHA loans, are suitable for borrowers with strong financial profiles. They provide access to competitive lending terms but require higher credit scores and down payments for eligibility.
Private lenders and GSEs like Fannie Mae and Freddie Mac offer conventional mortgages, necessitating thorough application processes and documentation. Interest rates for conventional loans are generally higher, emphasizing the importance of robust financial backgrounds for borrowers.