A conventional mortgage refers to a home loan that is not insured or guaranteed by a government agency such as the Federal Housing Administration (FHA), Department of Veterans Affairs (VA), or the U.S. Department of Agriculture (USDA). Instead, conventional mortgages are backed by private lenders, such as banks, credit unions, or mortgage companies.
Here are some key points to understand about conventional mortgages:
- Loan Requirements: Conventional mortgages typically have stricter eligibility requirements compared to government-backed loans. Lenders evaluate factors such as credit score, income, employment history, debt-to-income ratio, and the borrower's financial stability when determining loan approval.
- Loan-to-Value (LTV) Ratio: The loan-to-value ratio is the percentage of the home's appraised value that the lender is willing to finance. Conventional mortgages often require a lower LTV ratio, meaning borrowers may need a larger down payment compared to government-backed loans. A down payment of at least 20% of the home's purchase price is typically needed to avoid private mortgage insurance (PMI), which is an additional cost to protect the lender in case of default.
- Mortgage Insurance: If the down payment is less than 20%, private mortgage insurance (PMI) is usually required on conventional mortgages. PMI protects the lender if the borrower defaults on the loan. It is an additional monthly cost added to the mortgage payment until the homeowner reaches a certain level of equity in the home.
- Interest Rates: Conventional mortgage interest rates can vary depending on factors such as the borrower's credit score, loan term, loan amount, and current market conditions. Rates can be fixed (stay the same throughout the loan term) or adjustable (fluctuate over time).
- Loan Limits: Conventional mortgages have loan limits set by Fannie Mae and Freddie Mac, two government-sponsored enterprises that purchase and guarantee conventional mortgages on the secondary market. These loan limits vary by location and are periodically adjusted to reflect changes in home prices. Borrowers seeking loans that exceed the loan limits may need to consider jumbo loans, which have different requirements.
- Loan Terms: Conventional mortgages typically offer various loan terms, including 15-year and 30-year options. The loan term affects the monthly payment amount and the total interest paid over the life of the loan.
- Home Appraisal: Like other mortgage types, conventional mortgages require a home appraisal to determine the property's value and ensure it meets lending standards.
Conventional mortgages offer flexibility, competitive interest rates, and a range of loan options. They are commonly used for primary residences, second homes, and investment properties. It's important to compare different lenders, review loan terms, and seek pre-approval to understand the options available and find the best conventional mortgage that suits your financial situation and homeownership goals. Consulting with a mortgage professional or loan officer can provide personalized guidance tailored to your needs.