What makes a conventional mortgage conventional?
The term “Conventional” refers back to a time before the US
government began insuring certain types of loans (such as FHA and VA loans) and
loans were strictly between the borrower and the bank. Today, conventional
loans refer to those loans which still only involve borrower and bank, and are not
part of any federal government program. However, a conventional loan can still
be a “conforming” loan, meaning that it conforms with FNMA and FHLMC guidelines
so that it could be sold by your lender to one of these agencies. Lenders may
also choose to make “nonconforming” loans that cannot be sold to a government
When you make a down payment of less than 20% of the
purchase price, your lender may require you to purchase Private Mortgage
Insurance (PMI). This means you will be paying a little extra each month until
you’ve made enough payments towards principle to equal 20% of the original purchase
price. Keep in mind that this insurance protects the lender, not you, and that
you may still be liable for the outstanding balance in the event of a mortgage
Why use a conventional loan?
- Buy a more expensive property – many government programs have upper limits on the purchase price of the property you can buy with their program – with a conventional loan, you can borrow as much as the lender is willing to lend to you. These larger loans are commonly called “jumbo loans,” and different lenders will have their own rules about what you need to qualify.
- Buy a second, third, or investment property – many government programs are limited to use for owner-occupied properties; most cannot be used for the purchase of a vacation home or investment property. Conventional loans make these purchases possible.
- Lower cost to borrow – While government programs will often offer a competitive interest rate, the cost of processing these loans can add up, and contribute significantly to your closing costs and the lifetime cost of the loan. Borrowers seeking to minimize their closing costs and overall cost of borrowing may prefer some conventional loans.
- Pay less up front – while 3% is the minimum down payment required for a loan that can be sold to FNMA or FHLMC, some lenders will accept even less of a down payment for a nonconforming loan. This gives borrowers who otherwise could not purchase a home access to home ownership.