The phrase "conventional loan" is usually used to distinguish a mortgage that follows Fannie Mae or Freddie Mac guidelines from one that uses other standards, like FHA rules. Conventional loans are not insured by a government entity such as the Federal Housing Administration, or FHA. Depending upon your financial situation, conventional loans may offer several benefits over FHA or other non-traditional loans.
One of the most common reasons homebuyers choose a government-backed loan over a conventional loan is the lower down payment requirement. For a government-backed mortgage, such as an FHA loan, the buyer may need to provide as little as 3.5 percent of the mortgage amount. For most conventional loans, you will need to bring at least 10 percent to the table. There are exceptions to this rule, but they require close to perfect credit scores and an exceptionally low debt-to-income ratio.
Credit requirements for conventional loans are also a bit more stringent than government-backed loans. Homebuyers will need a credit score of at least 620 to obtain a conventional loan, and anything lower than a 740 is likely to rack up additional fees. A low credit score combined with a high debt-to-income ratio is especially problematic, according to Bankrate. Although some lenders will approve conventional mortgages for buyers with a credit score as low as 620, a score of 680 or more is ideal.
If you opt for a lower down payment with a conventional loan, you will also have to pay mortgage insurance. Although exact requirements vary based on your lender, most lenders require mortgage insurance if you provide a down payment of less than 20 percent of the loan value. However, unlike an FHA loan, a conventional mortgage does not require a mortgage insurance premium, or MIP, at closing time. This is a significant difference between the two, since MIP is usually about 1.5 percent of the total loan amount.
Is It Right For You?
If you have a large amount of cash in savings and good financial history, a conventional loan might be the best choice for you. Conventional loans provide a few advantages over FHA and other government-backed mortgages, such as higher equity. They also tend to have less "red tape" than government-backed loans, which have strict guidelines about the type of property you can obtain. As with any home loan, discuss all terms and conditions with your lender before you apply for the loan.