Jane Dotson
A privately insured conventional loan is a type of mortgage loan that is not insured or guaranteed by the government. Instead, it is backed by private lenders, and the insurance is usually paid by the borrower. Conventional loans are much more common than government-backed financing. They offer buyers more flexibility but are also riskier because they lack federal government insurance. This also means it can be harder to qualify for a conventional loan, which helps protect borrowers financially. Conventional loans are available as fixed-rate, adjustable-rate, conforming, jumbo, and non-qualifying mortgages.
| Characteristics | Values |
|---|---|
| Type of Loan | Mortgage |
| Insured or Guaranteed by the Government | No |
| Lender | Private |
| Insurance Paid By | Borrower |
| Down Payment | Minimum 3% |
| Credit Score | Minimum 620 |
| Debt-to-Income Ratio | Less than 43% |
| Private Mortgage Insurance | Required if down payment is less than 20% |
What You'll Learn
Private mortgage insurance (PMI)
There are several types of PMI:
- Borrower-paid PMI: The most common type, it is paid as a monthly fee in addition to the mortgage payment.
- Single-premium PMI: Paid upfront in a lump sum at closing, it lowers monthly payments but cannot be refunded if the borrower moves or refinances.
- Lender-paid PMI: The lender technically pays the premium, but the borrower covers the cost in the form of a higher interest rate.
- Split-premium PMI: A hybrid of borrower-paid and single-premium PMI, it requires a partial upfront payment and the remainder is added to monthly payments.
PMI is not permanent. It can be removed when the borrower has accumulated 20% equity in the home, or when the mortgage balance drops to 78% of the home's original value. The cost of PMI depends on factors such as the borrower's credit score, loan type, and down payment size.
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Conventional loan requirements
A conventional loan is a mortgage that is not directly insured or guaranteed by a government program. Most conventional loans are "conforming" loans, which means they meet the requirements for Fannie Mae or Freddie Mac. These are government-sponsored enterprises that purchase mortgages from lenders and sell them to investors.
Down Payment
The down payment requirement for a conventional loan depends on various factors. It can be as low as 3% for first-time home buyers. For those who are not first-time home buyers or are making no more than 80% of the median income in their area, the requirement is 5%. If the property is not a single-family home, the down payment may be 15%. For adjustable-rate mortgages, the minimum down payment is 5%.
If you put down less than 20%, you will need to pay for private mortgage insurance (PMI) to protect mortgage investors in case of a loan default. The cost of PMI varies based on the loan type, credit score, and down payment size. Once you reach 20% equity in the home, you can ask your lender to remove the PMI from your mortgage payments.
Credit Score
In most cases, a credit score of at least 620 is required to qualify for a conventional loan. A higher credit score can lead to lower interest rates and reduced PMI costs. A score of 720 and above will generally secure the most favourable rates.
Debt-to-Income Ratio
The debt-to-income ratio (DTI) represents the percentage of your monthly income that goes towards debt payments. Lenders prefer a DTI of under 36% but will commonly allow up to 43%. In some cases, a DTI as high as 45-50% may be acceptable if there are compensating factors such as a high credit score or significant cash reserves.
Loan Limits
For a conforming conventional loan, the loan amount must fall within the limits set by Fannie Mae and Freddie Mac. For 2024, the limit for a single-family home is $766,550, with higher limits for Alaska, Hawaii, and other high-cost areas, ranging up to $1,149,825.
Employment and Income
Lenders typically seek a two-year track record of steady income and employment. They may require proof of employment and income through financial documents such as bank statements and tax forms. Different types of income, such as salary, contract work, or gig work, can be considered.
Property Requirements
The property must meet specific criteria, including being a single-family or multi-unit home (no more than four units) and being used for residential, not commercial, purposes. For condos, at least 51% of the total units must be owner-occupied or second homes.
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Types of conventional loans
Conventional loans are mortgages that are not insured or guaranteed by the government, such as under Federal Housing Administration, Department of Veterans Affairs, or Department of Agriculture loan programs. They are popular among first-time home buyers and repeat buyers.
There are two main categories of conventional loans: conforming and non-conforming. Conforming loans have maximum loan amounts set by the government, while non-conforming loans are less standardized, with eligibility, pricing, and features varying by lender. Here are some of the common types of conventional loans:
Fixed-Rate Conventional Loans
With a fixed-rate conventional loan, the interest rate remains the same for the duration of the loan. Borrowers often opt for a 30-year fixed-rate conventional loan, but shorter terms are also available.
Adjustable-Rate Conventional Loans
The interest rates on adjustable-rate conventional loans, also known as hybrid ARMs, can fluctuate over time. ARM rates typically adjust annually after an initial fixed-rate period.
Conforming Conventional Loans
Conforming conventional loans adhere to the loan limits set by the Federal Housing Finance Agency and the additional standards established by Fannie Mae or Freddie Mac. These loans are also known as "GSE loans" since Fannie Mae and Freddie Mac are government-sponsored enterprises.
Nonconforming Conventional Loans
Nonconforming conventional loans exceed FHFA loan limits or utilise underwriting standards different from those set by Fannie Mae and Freddie Mac. A jumbo loan is a common type of nonconforming conventional loan, used when the loan amount surpasses the conforming limit of $766,550 in most U.S. counties.
Low-Down-Payment Conventional Loans
Contrary to popular belief, a 20% down payment is not always necessary to purchase a house. In fact, first-time buyers typically put down 8% on average. HomeReady and Home Possible are conventional mortgage options that allow for down payments as low as 3%, also known as "3 down conventional loans."
Conventional Renovation Loans
The CHOICERenovation loan and HomeStyle loan are two types of conventional mortgages that allow borrowers to finance both the purchase of a fixer-upper and the necessary renovations simultaneously.
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Conventional loans vs. government loans
A conventional loan is any mortgage loan that is not insured or guaranteed by the government. Conventional loans are available with several different term options, with most people choosing between 15-year and 30-year terms. They are a good option for homebuyers with a strong credit history, stable income, and the ability to make a down payment of at least 5%.
Most conventional loans are conforming loans, which means they meet the requirements for Fannie Mae or Freddie Mac. Both are government-sponsored enterprises that purchase mortgages from lenders and sell them to investors.
If you put down less than 20% on a conventional loan, you’ll be required to pay for private mortgage insurance (PMI) to protect mortgage investors in case of a loan default.
Government-backed loans, on the other hand, make homeownership possible for borrowers with lower credit scores and less savings for a down payment. They are typically guaranteed by government funds that provide extra protection for lenders, making it easier to qualify for these loans since the risk to lenders is lower.
FHA loans, for example, are intended for low- and moderate-income homebuyers, allowing for lower credit scores than conventional loans and a lower down payment of 3.5%. FHA loans do have a monthly mortgage insurance cost, but it is lower than conventional mortgage insurance premiums.
VA loans are available for borrowers who have served or are serving in the military and do not require a down payment. However, an upfront VA funding fee may be required.
USDA loans are for low- to moderate-income borrowers to buy a single-family home in a qualifying rural or suburban area. They have low fixed rates, flexible credit requirements, and require no down payment. However, a funding fee and monthly mortgage insurance are charged by the USDA.
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Pros and cons of conventional loans
A conventional loan is any mortgage loan that is not insured or guaranteed by the government. Conventional loans are backed by private financial institutions, such as banks and credit unions. They are available with several different term options, with most people choosing between 15-year and 30-year terms.
Pros
- Lower interest rates: Conventional loans base interest rates on credit scores, so those with a high credit score will see lower interest rates.
- More flexible loan options: There are a variety of loan terms available, such as a 30-year or 15-year mortgage. This allows borrowers to choose loan terms that best fit their budget.
- Less property restrictions: Conventional loans can be used for second homes or investment properties, unlike government-backed loans.
- Competitive interest rates and terms: The better your credit score, the better your chance of securing lower interest rates.
- Option to remove private mortgage insurance: If you make a down payment of at least 20% or reach 20% equity in your home, you can cancel your private mortgage insurance.
- Higher loan limits: Conventional loans offer higher loan limits than government-backed loans.
Cons
- Stricter credit requirements: In order to get the most attractive interest rate and terms, you have to meet the higher credit score requirements.
- Higher down payment amounts: If you’re not a first-time home buyer, you may be expected to put down a higher percentage of the total cost as a down payment.
- Down payment affects private mortgage insurance: With a down payment of less than 20%, you’re required to pay for private mortgage insurance, which increases the overall cost of your loan.
- More difficult to qualify: Many lenders will not consider potential borrowers with a credit score below 620, making it more difficult to qualify for a conventional loan.
- Stricter qualifying guidelines: Lenders take on greater risk with conventional loans, so they will examine your financial history and situation more closely than they would for a government-insured loan.
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Frequently asked questions
A privately insured conventional loan is a mortgage not insured or guaranteed by the government but by private lenders. It is common for borrowers to be required to pay for private mortgage insurance (PMI) if their down payment is less than 20%.
Privately insured conventional loans are not insured or guaranteed by a federal agency, whereas government-insured loans are backed by federal agencies such as the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), or the Department of Agriculture (USDA).
Privately insured conventional loans offer borrowers more flexibility in terms of down payment options and loan term lengths. They also allow for faster loan processing and provide the option to remove PMI once the borrower has reached 20% equity in the home.
One of the main disadvantages is that privately insured conventional loans typically require a down payment, whereas some government-insured loan options do not. Additionally, the approval requirements for conventional loans tend to be stricter, including a higher credit score and a lower debt-to-income ratio.
To qualify for a privately insured conventional loan, you will need to meet the lender's requirements regarding credit score, income, and debts. This typically includes a minimum credit score of 620, a debt-to-income ratio of no more than 43-45%, and a down payment of at least 3-5%.
