Any residential mortgage loan that is not insured or guaranteed by the federal government is referred to as a “conventional mortgage.” The term conventional refers to a standard, regular, or normal, which means that conventional loans are typical and common.
That makes sense given that conventional home loans account for the lion’s share of mortgages issued in the United States. Government mortgages, on the other hand, account for the remainder, albeit a smaller portion of the pie. (How to Find the Best Mortgage Lender in 6 Easy Steps)
Conventional mortgage loans, as you might expect, can be fixed or adjustable-rate mortgages, such as 30-year fixed, 15-year fixed, hybrid ARMs, interest-only loans, and so on.
Basically anything and everything under the sun. They can be used to buy a house or to refinance an existing mortgage.
Be careful not to mix up conventional and conforming mortgages, as the two terms can be very different, despite being used interchangeably by lenders and reporters.
Let us take a moment to consider the distinction between conventional and conforming behavior.
In terms of the second statement, there are non-government mortgages that exceed the loan limits allowed by conforming mortgages, making them non-conforming conventional loans.
As an example, consider the jumbo loan, which is convenient but not conforming due to the loan amount. (How to Find the Best Mortgage Lender in 6 Easy Steps)
Because conventional loan limits (maximum loan amounts) are not governed by any specific entity, there are none.
As a result, any private sector (non-government) mortgage lender can lend as much as they want to a borrower, even up to $5 million.
Furthermore, there is no set loan eligibility standard that they must follow, so underwriting criteria can vary greatly.
In terms of the loan amount, down payment, credit score, and overall risk, conventional loans can be all over the place. Nonetheless, because they are not government loans, both types of loans are considered conventional. (How to Find the Best Mortgage Lender in 6 Easy Steps)
Furthermore, conforming loans require a minimum credit score of 620 and a maximum loan-to-value ratio (LTV) of 97 percent, whereas non-conforming conventional loans may allow lower credit scores and even higher LTVs.
Nowadays, conventional mortgages (whether conforming or nonconforming) typically require a larger down payment and a higher credit score than government loans.
In addition, if the LTV on a conventional loan exceeds 80%, the mortgage lender will usually require private mortgage insurance.
Conventional mortgages, on the other hand, may offer more flexibility because banks can set their mortgage underwriting guidelines and risk appetite.
Loan requirements will vary by bank and lender, rather than being dictated by rigid government or quasi-government guidelines.
For example, if a traditional lender wants to approve mortgages with 500 credit scores or no down payment, they can.
This is assuming they are willing to take such risks, as they are private entities with no accountability other than adhering to ATR rules.
Now, let us discuss mortgage loans that are backed by the federal government, colloquially referred to as “government loans” or “govie loans.”
These are considered unconventional because they are backed by the government. That is the end of the story.
Therefore, if your mortgage is guaranteed by the government, it is considered non-traditional.
Take note that I said insured and backed, not government-funded. The government does not make these loans directly but rather contracts them out to private companies.
The FHA loan is the most popular government loan. It is a mortgage-backed by the Federal Housing Administration (FHA), a division of the Department of Housing and Urban Development’s (HUD) Office of Housing.
While FHA loans allow for down payments as low as 3.5 percent, mortgage insurance is required regardless of the loan-to-value ratio (LTV).
Additionally, there are FHA loan limits that specify the maximum amount a homeowner may borrow based on their county of residence (or plan to reside).
By the way, the mortgage insurance (MI) paid on an FHA loan is distinct from the private mortgage insurance (PMI) paid on conventional loans.
The latter is provided by a private sector company and is subject to different rules regarding removal and costs. (How to Find the Best Mortgage Lender in 6 Easy Steps)
The FHA gained popularity following the mortgage crisis, owing to its low down payment and lenient (low) credit score requirements.
Indeed, many argue that FHA lending has largely displaced subprime lending, though this was not the case during the housing boom.
Nobody was interested in government loans because the most attractive (i.e. risky and liberal) loan programs were available from private, conventional lenders.
The VA loan, which is backed by the Department of Veteran Affairs, is another popular and widely used government home loan.
As the name implies, it is restricted to military personnel and their families, in contrast to the FHA, which is available to anyone who otherwise qualifies.
Finally, there is the USDA home loan program, which offers 100% financing (no down payment required) on purchase mortgages to borrowers in rural neighborhoods across the country.
In that regard, it also has a limited reach, which makes FHA loans the king of government loans. (How to Find the Best Mortgage Lender in 6 Easy Steps)
For the record, the majority of mortgage lenders and brokers originate both conventional and government-backed mortgage loans.
Alternatively, they may argue that you are compelled to go in one direction due to a low credit score or a large loan balance.
FHA loans were extremely popular following the housing market crash a decade ago, owing to their low credit score requirements and low down payment requirements.
If you are in the market for a mortgage, it is critical to understand the distinctions between these three major loan types.
One may be more suitable for you for a variety of reasons, and it is always a good idea to be aware of all your loan options.
If a lender recommends one over the other, ensure they fully explain their reasoning.
If you live in a more expensive region of the country (or are simply purchasing an expensive home for your area), you may be forced to take the conventional route simply due to the home’s value. (How to Find the Best Mortgage Lender in 6 Easy Steps)
725 N. Hickory Avenue; Suite 200
Bel Air, MD
Office : 443-619-7900