Jane Dotson
A conventional loan is any home loan that is not guaranteed or insured by a government agency. Conventional loans are the most common type of mortgage, accounting for over 77% of all mortgages in 2023. They are not insured by the government and have specific requirements that vary by lender. Conventional loans can be conforming or non-conforming. Conforming loans, which make up most conventional mortgages, adhere to the standards set by government-sponsored enterprises Fannie Mae and Freddie Mac. These loans are limited to $806,500 for a single-family home in most counties but can go up to $1,209,750 in higher-cost markets. While a minimum down payment of 3% is required, borrowers will need to pay private mortgage insurance (PMI) if they put down less than 20%. This insurance can be cancelled once the borrower has 20% equity in their home.
| Characteristics | Values |
|---|---|
| Definition | Any mortgage loan that is not insured or guaranteed by the government. |
| Insured by the government | No |
| Conforming | Can be conforming or non-conforming |
| Limit | $806,500 for a single-family home in most counties but can go as high as $1,209,750 in higher-cost markets |
| Down payment | 3% minimum, but you'll pay private mortgage insurance (PMI) for anything less than 20% |
| Credit score | Minimum 620 |
| Interest rates | Potentially higher than government-backed loans |
| Bankruptcy or foreclosure | Must wait 2-4 years after bankruptcy and 3-7 years after foreclosure |
| Popularity | Most common type of mortgage, making up over 77% of all mortgages in 2023 |
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What You'll Learn
Conventional loans are not insured by the government
A conventional loan is any mortgage loan that is not insured or guaranteed by a government agency. This includes federal agencies such as the Federal Housing Administration, the Department of Veterans Affairs, and the Department of Agriculture. Conventional loans can be insured by private companies, in the form of Private Mortgage Insurance (PMI), which is required if the borrower's down payment is less than 20%. The PMI can be cancelled once the borrower has 20% equity in their home.
Conforming conventional loans are guaranteed by government-sponsored enterprises Fannie Mae and Freddie Mac. These loans adhere to standards set by these enterprises, which purchase the mortgages, sell them to investors, and help keep the mortgage market liquid. Conforming loans are limited to $806,500 for a single-family home in most counties but can go up to $1,209,750 in higher-cost markets.
Non-conforming conventional loans do not meet the standards set by Fannie Mae and Freddie Mac. These loans are not insured or guaranteed by any government agency and have their own specific requirements, which vary by lender.
Conventional loans are the most popular type of mortgage, with over 77% of all mortgages originated in 2023 falling into this category. They offer flexibility in terms of the source of the down payment, which can come from savings, a gift from a relative or friend, or a down payment assistance program. They also allow borrowers to shop around for the best interest rates and terms, as underwriting standards vary between banks.
In summary, conventional loans are not insured by the government but offer borrowers the advantage of flexibility and potentially lower interest rates compared to government-backed loans.
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Conforming loans are backed by Fannie Mae and Freddie Mac
Conventional loans are any mortgage loans that are not insured or guaranteed by the government. They can be conforming or non-conforming. Conforming loans are those that meet the lending criteria set by government-sponsored enterprises, Fannie Mae and Freddie Mac. These enterprises were created by Congress to promote homeownership and stabilise the mortgage market. They do not lend directly to borrowers and do not set mortgage rates, but they buy conforming loans from lenders to ensure they have enough funds to continue lending. This process is known as the secondary mortgage market.
Fannie Mae and Freddie Mac set the lending criteria for conforming loans to encourage borrowers to buy homes they can comfortably afford. These criteria include credit history, debt levels, and current income. Homebuyers with conforming loans are less likely to default on their loans and face foreclosure. Conforming loans often come with lower interest rates compared to non-conforming loans due to their GSE backing.
Fannie Mae and Freddie Mac guarantee timely repayment of principal and interest on the underlying loans in the mortgage-backed securities they sell. This reduces risk for lenders and investors, allowing them to offer better terms to borrowers. These guarantees also contribute to the availability of 30-year fixed-rate loans and make loans more affordable.
While Fannie Mae and Freddie Mac share similarities, they also have some key differences. For example, Fannie Mae buys mortgages from larger commercial banks, while Freddie Mac purchases from community banks, regional banks, and credit unions. Additionally, they have different guidelines for down payment requirements and lending requirements.
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Private mortgage insurance (PMI) is required for down payments under 20%
Private mortgage insurance (PMI) is a type of insurance that is typically required when taking out a conventional loan with a down payment of less than 20% of the purchase price or value of the home. PMI is designed to protect the lender in the event that the borrower defaults on their loan payments. It is important to note that PMI does not provide any financial protection for the borrower and that they can still lose their home through foreclosure if they fall behind on their mortgage payments.
The cost of PMI depends on several factors, including the size of the mortgage loan, the down payment amount, and the borrower's credit score. Generally, the larger the loan and the lower the down payment and credit score, the higher the PMI cost. The average annual cost of PMI typically ranges from $30 to $70 per $100,000 borrowed, and it is usually paid as a monthly premium added to the borrower's mortgage payment. However, some lenders may offer alternative payment options, such as a one-time upfront premium paid at closing or a combination of upfront and monthly payments.
It is possible to avoid PMI by making a 20% down payment on a conventional loan. Additionally, PMI can be removed from monthly mortgage payments once the borrower has achieved 20% equity in their home or has paid down their loan balance below 80% of the home's purchase price. In some cases, borrowers may need to demonstrate a consistent payment history to qualify for PMI removal.
While PMI can increase the cost of a loan, it also provides an opportunity for homebuyers to qualify for a loan they might not otherwise be able to obtain. It allows homebuyers to make a smaller down payment while still offsetting some of the risks to the lender. When considering PMI, it is important for homebuyers to assess their financial situation and explore the different PMI choices offered by lenders to find the option that best suits their needs.
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Conventional loans are the most common type of mortgage
A conventional loan is any mortgage loan that is not insured or guaranteed by a government agency. These include the Federal Housing Administration, Department of Veterans Affairs, or Department of Agriculture loan programs. Conventional loans can be conforming or non-conforming. Conforming loans, which make up most conventional mortgages, adhere to the standards set by Fannie Mae and Freddie Mac, two government-sponsored enterprises that purchase mortgages, sell them to investors, and help keep the mortgage market liquid. These enterprises also back most conventional loans, making mortgages more accessible and affordable for moderate-income people.
However, conventional loans usually have higher interest rates compared to government-backed loans. They also require a higher credit score of at least 620 and scrutinise past hardship more closely, requiring a longer wait time after bankruptcy or foreclosure.
Conventional loans may require private mortgage insurance (PMI) if the down payment is less than 20%. The average monthly cost of PMI is 0.46% to 1.5% of the loan amount, and you can request to cancel these premiums when your loan-to-value ratio hits 80%.
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FHA loans are insured by the Federal Housing Administration
A conventional loan is any mortgage loan that is not insured or guaranteed by the government. Instead, conventional loans that meet conforming lending guidelines are guaranteed by Fannie Mae and Freddie Mac. These are government-sponsored enterprises that set the lending criteria for conforming loans to encourage homebuyers to buy homes they can afford.
On the other hand, FHA loans are insured by the Federal Housing Administration. The Federal Housing Administration (FHA) provides mortgage insurance on single-family, multifamily, manufactured home, and hospital loans made by FHA-approved lenders throughout the United States and its territories. FHA-insured loans are government-backed loans designed to help a broader range of Americans, particularly first-time homebuyers, achieve homeownership. These loans offer more flexible credit, income, and down payment requirements than conventional loans. Offered through FHA-approved lenders, these loans are widely used as a practical and accessible solution for individuals who may not qualify for traditional financing due to limited savings or credit history.
The FHA was established by the National Housing Act of 1934 to increase home construction, reduce unemployment, and operate various loan insurance programs. The FHA does not make loans, nor does it plan or build houses. Instead, applicants for FHA loans must make arrangements with a lending institution, which may ask if the borrower wants FHA insurance on the loan or may insist that the borrower apply for it. The federal government investigates the applicant and, having decided that the risk is favourable, insures the lending institution against loss of principal if the borrower fails to meet the terms and conditions of the mortgage.
The FHA offers several types of mortgage products, including the FHA Fixed-Rate Mortgage, which provides a stable interest rate for the life of the loan, typically in 15-year or 30-year terms. The FHA also insures Adjustable-Rate Mortgages (ARMs), which start with a fixed interest rate for an initial period and then adjust annually based on market conditions. All FHA loans require mortgage insurance premium (MIP) irrespective of the size of the mortgage, down payment, and credit score. To obtain mortgage insurance from the FHA, borrowers must pay an upfront mortgage insurance premium (UFMIP) equal to 1.75% of the base loan amount at closing. There is also a monthly mortgage insurance premium (MIP) that varies based on the amortization term and loan-to-value ratio.
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Frequently asked questions
A conventional loan is any mortgage loan that is not insured or guaranteed by the government. Conventional loans can be conforming or non-conforming.
Government-backed loans are guaranteed by various government agencies, meaning that if a borrower defaults on their loan, the agency will pay the lender for its losses. Conventional loans, on the other hand, are not insured or guaranteed by the government and have their own specific requirements that often vary by lender.
You will need to pay for private mortgage insurance (PMI) if you put less than 20% down on a conventional loan. The average monthly cost of PMI is 0.46% to 1.5% of the loan amount. You can request to cancel these premiums when your loan-to-value (LTV) ratio reaches 80%.
