What is a Conventional Loan Mortgage? Rates and Requirements 2021

Part of the quintessential American dream is owning your own home. But to do that, you’ll likely need to take out a mortgage loan since chances are you don’t just have a few hundred thousand dollars in your pocket. 

Fortunately, conventional loan mortgages make acquiring a home of your own relatively easy and affordable, no matter what your financial situation or specifics. Let’s break down what conventional loan mortgages are, as well as look at their typical rates and requirements, in this guide.

What is a Conventional Loan? 

In a nutshell, a conventional loan is a specific kind of mortgage loan. As opposed to government-backed loans, conventional loans are never insured or guaranteed by the government.

They’re called “conventional” because these loans are backed by private lenders. Furthermore, any insurance for the loan is paid by the borrower themselves. This makes them similar to typical loans for lower-priced items – they’re only distinct because some people opt for government-backed mortgage loans due to those loans’ relatively high prices.

In fact, most people choose conventional loans compared to relying on government-backed financing for their mortgages. These loans provide slightly greater flexibility in terms of loan limits, amounts, and other aspects. But they lack a bit of the security provided by government-backed loans. Plus, it can sometimes be tricky to qualify for good ones.

How Does a Conventional Mortgage or Loan Work? 

A conventional mortgage loan or conventional loan works the same as any other mortgage. Again, these loans are the primary type used by most people who own homes in America.

Say that you want to buy a home priced at $300,000. If you have $30,000 on hand, you can make a down payment of $30,000 or 10%, and take the price down to $270,000.

You can still buy the house immediately and start living in it if you take out a conventional loan for the remaining sum of $270,000. Different aspects of the conventional loan will determine how much you pay every month until the house is yours.

  • The interest rate is a small percentage that adds a bit of interest every month the mortgage is still active
  • The monthly rate is the set amount you will pay each month, plus the interest rate
  • The term limit is how long the mortgage is projected to take to pay off. Typical term lengths range from 10 years to 30 years

With a hypothetical interest rate of 3.99%, you’d actually need to pay $280,773. If you signed up for a 30-year term limit, that would mean that you’d need to pay $9359.10 every year. That takes your overall mortgage payment every month to just $779.93.

Types of Conventional Loans: Conforming vs Nonconforming

There are two primary types of conventional loans. Let’s break them down individually.

Conforming Conventional Loans

These loans are “conforming” since they meet loan guidelines set by the lending conglomerates Fannie Mae and Freddie Mac (which are themselves terms for the Federal National Mortgage Association and Federal Home Loan Mortgage Corporation, respectively). In essence, both of these conglomerates are government-sponsored companies that purchase mortgages from lenders in order to drive market movement and inspire market confidence.

In order for a loan to meet their guidelines, a given conventional loan must meet a specific limit. For instance, 2018 had a baseline loan limit for any one-unit properties of $453,100. That’s the maximum amount that someone could borrow. This amount changes regularly to match shifts in the housing market.

A conforming conventional loan is often an attractive choice; they’re usually pretty stable and are backed by both of the above enterprises. However, as the 2008 recession showed us, even Fannie Mae and Freddie Mac are not immune to market over-speculation.

Nonconforming Conventional Loans

The flip side to conforming conventional loans are, of course, nonconforming conventional loans. These are any loans that exceed the loan limit set by Fannie Mae and Freddie Mac. Thus, these loans are always funded by either private institutions or other lending enterprises.

There’s no real strict downside to choosing a nonconforming conventional loan. There just may be fewer of them available since most lenders (and borrowers, to be fair) have a great amount of confidence in Fannie Mae and Freddie Mac and thus choose to create loans that can be purchased by either enterprise.

Conventional Loan vs. Government-Backed Loan

Typically, people purchase homes in the United States using one of two types of loans: conventional loans or government-backed loans. Most government-backed loans are included in various support packages, such as VA loans. These are loans only available to veterans of the U.S. Armed Forces.

Other variations of these loans include Federal Housing Administration Loans. Either way, both of the above loan examples are guaranteed by their backing federal organizations.

These loans often include excellent terms or security aspects to make them attractive to their borrowers. For example, FHA loans require that borrowers put at least 3.5% down. Furthermore, borrowers have to pay the MIP or mortgage insurance premium as part of their monthly mortgage payments.

Similarly, VA loans don’t require any down payment for a house, although borrowers do have to pay a single time funding fee that is often between 1 and 3% of the total loan amount.

In contrast, conventional loans’ lenders are at risk if borrowers default on the loan. For instance, if you default on your loan payments, the lender for your conventional loan will instead try to minimize the losses by selling your house as quickly as possible or pushing your mortgage and foreclosure.

Because of this inherent extra risk, conventional loans usually require borrowers to pay private mortgage insurance if they ever put less than 20% down initially.

How to Qualify for a Conventional Loan

Want to know if you qualify for a conventional loan? You’ll need to contact any potential lender and ask directly.

The lender will ask for a variety of financial information, including your bank statements, tax returns, and more. All of this will help them to see if you have a steady income and will likely be able to make your mortgage payments on time.

Furthermore, you’ll need enough cash on hand to make a down payment. Down payment amounts can range from as little as 3% all the way up to 20% or higher. 10% is recommended if you can afford it, while 20% will allow you to avoid paying private mortgage insurance every month with your regular mortgage payments.

If you have enough income and enough cash to make a down payment, as well as other factors like a good credit history, you’ll likely qualify for a conventional loan. Remember, these loans are quite typical and millions of people qualify for them every year.

Typical Conventional Loan Rates

As we saw in our earlier example, conventional loan attributes, such as their interest rates and term limits, can vary wildly. However, typical conventional loan attributes include:

  • Interest rates of around 3.99%
  • Term limits ranging from 10 years to 30 years
  • Down payment requirements of around 10% of the total asking price

Benefits of Conventional Loans

While government-backed loans do have some advantages, conventional loans also have some unique benefits that their rigid, government-backed counterparts can’t offer.

For example, conventional loans typically have:

  • Low interest rates. This means that your monthly payments will both be relatively affordable and you won’t pay much more over the lifespan of your mortgage compared to the initial asking price for your home
  • Quick processing. In other words, it’s easy to get quickly approved for a conventional loan if you want to buy a house in the near future
  • Lots of down payment and term lengths for fixed-rate mortgages. For instance, down payment amounts range from as low as 3% of the initial sale price to as high as 20%. Meanwhile, term lengths can range from 10 years to 30 years depending on how much you want to pay every month
  • Generally lower private mortgage insurance if you make a down payment of less than 20%

Basically, lots of people go for conventional loans since they are very flexible and can suit a wide variety of financial situations or payment plans. Furthermore, many people don’t qualify for government-backed loans since they aren’t veterans.

Summary

As you can see, conventional loans are flexible mortgage options you can use to secure a home without having hundreds of thousands of dollars on cash when it’s time to buy. Compared to government-backed loans, conventional loans are available to most people and it’s relatively easy to find a loan that works for your unique financial situation.

Want more financial guidance? Be sure to contact Seek Capital for more loan advice!

 

Sources

https://www.fhfa.gov/SupervisionRegulation/FannieMaeandFreddieMac/Pages/About-Fannie-Mae—Freddie-Mac.aspx

https://www.experian.com/blogs/ask-experian/what-is-a-government-backed-mortgage/

https://www.investopedia.com/terms/m/mortgage.asp

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