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There are “Agency” loans that are regulated by Fannie Mae and Freddie Mac (called GSE’s, or government sponsored agencies).
There are also “Gov’y” Loans, or Government Loans guaranteed by the government, including FHA – Federal Housing Administration, VA -Department of Veterans Affairs, or USDA – Department of Agriculture loan programs).
In contrast, Conventional Loans are originated and funded by private lenders, banks, credit unions, and other financial institutions. They are not insured or guaranteed by the government.
They can be “conforming” or “non-conforming” to the regulations of Fannie Mae or Freddie Mac, the GSEs.
Here are some key features and characteristics of conventional loans:
Lack of Government Insurance or Guarantee:
- Conventional loans do not have government insurance or guarantees, which means that the lender takes on more risk. If the borrower defaults on a conventional loan, the lender does not have a government agency to cover their losses. This often means that conventional loans have stricter credit and income requirements compared to government-backed loans.
- Conventional loans typically require a down payment, and the size of the down payment can vary. Traditionally, borrowers have been required to put down at least 20% of the home’s purchase price to avoid private mortgage insurance (PMI). However, some lenders now offer conventional loans with down payments as low as 3% to 5%. When the down payment is less than 20%, PMI is usually required to protect the lender in case of default.
- Conventional loans typically have higher credit score requirements compared to government-backed loans. Borrowers with stronger credit histories are more likely to qualify for favorable interest rates and loan terms.
The interest rates on conventional loans can vary depending on market conditions, the lender’s policies, and the borrower’s creditworthiness. Generally, borrowers with better credit scores and larger down payments can secure lower interest rates.
Conventional loans can be used for a wide range of property types, including single-family homes, condos, and multi-unit properties. There are also conventional conforming loan limits set by the Federal Housing Finance Agency (FHFA). Loans that exceed these limits are known as jumbo loans and often have stricter requirements.
Conventional loans are available with various loan terms, with 30-year and 15-year fixed-rate mortgages being the most common options. Borrowers can also find adjustable-rate mortgage (ARM) options with conventional loans.
Private Mortgage Insurance (PMI):
If the borrower’s down payment is less than 20% of the home’s purchase price, private mortgage insurance is typically required. PMI protects the lender in case of default but adds an additional cost to the borrower’s monthly mortgage payment.
Conventional loans can be used for primary residences, second homes, and investment properties.
Lower down payment than an FHA loan. You can put down only 3% on a conventional loan, which is lower than the 3.5% required by an FHA loan.
Competitive mortgage insurance rates. The cost of PMI that kicks in if you don’t put at least 20% down may sound onerous, but it’s less expensive than FHA mortgage insurance and, in some cases, the VA funding fee
Higher maximum DTI. You’ll be able to stretch up to a 45% DTI, which is higher than FHA, VA or USDA loans typically allow.
Flexibility with property type and occupancy. This makes conventional loans a great alternative to government-backed loans, which are restricted to borrowers who will use the property as a primary residence.
Generous loan limits. The loan limits for conventional loans are often higher than for FHA or USDA loans.
Higher down payment than VA and USDA loans. If you’re a military borrower or live in a rural area, you can use these programs to get into a home with zero down.
Higher costs for DTIs over 40%. Although you can qualify with a 45% DTI, starting Aug. 1, 2023, borrowers with DTIs over 40% may pay increased interest rates or an extra fee at closing.
Higher minimum credit score: Borrowers with a credit score under 620 won’t be able to qualify. This is often a higher bar than government-backed loans.
Higher costs for certain property types and nonoccupying borrowers. Conventional loans come with increased fees for manufactured homes, second homes, condos, investment properties and two- to four-unit properties.
Vashon Mortgage – NMLS #2431410 & Collen & Associates CA DRE #01452367
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Randal Collen MLO #2386273 & DRE #01452367