When you apply for a mortgage, you can choose to apply for a government-backed loan, such as an FHA loan or VA loan, or a conventional loan. Government-backed loans are insured by the government, whereas conventional loans are insured through private companies.
As conventional loans are not backed by the government, they represent a higher risk to lenders. This means credit and income requirements are more stringent, although these loans do offer several advantages to qualifying buyers.
Advantages of a Conventional Mortgage
Conventional mortgages are ideal for home buyers who have excellent credit and a substantial down payment. Conventional loans may be used to purchase a primary home, a second home or an investment home. This is unlike government-backed mortgages, which may be used exclusively for a primary residence. Conventional home loans are also available in 10, 1, 20, 25, 30 and 40-year terms, as well as Fixed-rate and adjustable-rate mortgages (ARMs).
- Fees are less than an FHA loan
- Private mortgage insurance (PMI) is only required on a conventional loan with less than 20% down. The PMI can be canceled once the balance falls to a certain level, whereas the mortgage insurance on an FHA loan remains for the life of the loan.
- Down payment as low as 5% for qualifying buyers; although many conventional loans require 10-20% down.
- Conventional mortgages generally close faster than government-backed loans.
Requirements for a Conventional Home Loan
Conventional mortgages are traditionally harder to obtain than a government-backed mortgage. Conventional mortgage lenders want to see:
- A credit score of at least 740
- A down payment of at least 5%. A down payment of less than 20% will require private mortgage insurance (PMI), which remains on the loan until the borrower reaches an 80% loan-to-value ratio.
- Monthly housing costs do not exceed 28% of the borrower's gross monthly income.
- Monthly debt (including credit card and car loan payments) must not exceed 36%.
- Must be discharged from a Chapter 7 bankruptcy for at least four years.
For some borrowers, a conventional mortgage offers greater savings over a government-backed mortgage, particularly an FHA loan. In recent years, FHA loans have experienced rising costs and mortgage insurance, that now remain for the life of the loan. Borrowers who can qualify for and afford a conventional mortgage are often encouraged to use this option over a government-backed loan.
If you are deciding between a government-backed mortgage or a conventional mortgage, consider your priorities. If you have excellent credit and can afford a down payment of at least 20%, a conventional mortgage may be the best option. If you would prefer a smaller up-front down payment, but a larger monthly payment with mortgage insurance, a government-backed mortgage may better serve your needs.
Keep in mind that conventional mortgage requirements vary greatly by lender. The down payment required, as well as other qualifications, may change dramatically, so it is important to compare lenders to find the most favorable conventional mortgage for your situation.