A conventional home mortgage loan – one backed by private lenders instead of a government agency – is the most common type of financing used by home buyers. Conventional home loans offer several advantages and disadvantages that are important to understand.
Take the time to learn why many home sellers prefer buyers with conventional mortgage loans, the eligibility requirements, and what to consider if you have a different kind of mortgage loan or face rejection obtaining conventional financing.Check your home buying options. Start here
In this article (Skip to...)
- What is a conventional home loan?
- Pros and cons of a conventional mortgage
- Who qualifies for a conventional loan?
- Why sellers prefer conventional loans
- Tips for non-conventional loan borrowers
What is a conventional home loan and how does it work?
A conventional mortgage loan is a type of home loan that is guaranteed by private lenders such as banks, mortgage companies, and credit unions. It is not backed by any government agency like the Federal Housing Administration (FHA), Department of Veterans Affairs (VA), or US Department of Agriculture (USDA), which guarantee non-conventional financing like FHA loans, VA loans, and USDA loans, respectively.Check your home buying options. Start here
Conventional loans follow guidelines set by Fannie Mae and Freddie Mac, federally-backed entities formed by the US Congress. These entities play a pivotal role in bolstering stability, liquidity (consistent access to funds on reasonable terms), and affordability to the mortgage market and the numerous lenders that offer home financing.
Freddie Mac and Fannie Mae facilitate this by purchasing mortgage loans from lenders. They either retain these loans in their portfolios or package the mortgages into mortgage-backed securities that are up for sale.
As with any type of home loan, lenders of conventional mortgage loans provide funds to qualified borrowers to purchase a property. In exchange, borrowers agree to repay the funds with a fixed-rate or adjustable-rate interest attached over a set term, such as 30 or 15 years.
“Because conventional loans are not supported by the government, lenders who offer them want to make sure you can bear the financial cost of paying back your loan, in addition to your other debts. So they impose certain qualification restrictions for conventional mortgage loans,” says Rinal Patel, a real estate investor and founder of Webuyphillyhome.com.
What are the pros and cons of a conventional mortgage loan?
Understanding these pros and cons of conventional loans will empower you to make informed decisions when securing home financing. So, let’s explore the merits and limitations of conventional mortgages to help you navigate this significant aspect of home buying.Get preapproved for a mortgage. Start here
Conventional loans pros:
- A higher loan limit than many government-backed mortgages
- A remarkable degree of flexibility in their terms. Repayment periods can range from 10, 15, 20, 25, and 30 years. Some lenders even allow you to pick a customized loan term, such as 8 years.
- Conventional loans are available with either fixed or adjustable interest rates. Note that adjustable rates remain fixed, but only for a period of time early in the term — typically the first 3, 5, or 7 years. During this initial fixed-rate phase, homeowners benefit from lower interest rates, potentially saving thousands.
- Unlike government loans that can charge an upfront insurance fee ranging from 1% to 4% of your loan amount, conventional loans do not impose an initial mortgage insurance fee, regardless of whether or not you make a down payment of less than 20%. However, If you put down less than 20%, you will need to pay monthly mortgage insurance premiums.
- A wider variety of lenders offer conventional loans, making it relatively easier to find lenders offering these loans compared to government-backed alternatives.
- Virtually any borrower and home location is eligible for a conventional loan (if you meet the lender’s requirements). On the other hand, to get a VA loan, you must be an active military member, veteran, or surviving spouse, and USDA loans limit the locations where you can purchase a home.
- Sellers are typically more willing to accept an offer from a buyer preapproved for a conventional loan.
Conventional loans cons:
- You may pay a higher fixed interest rate, especially if you have a lower credit score.
- Lenders typically uphold stricter eligibility criteria and may require a higher minimum credit score than those offering government loans.
- While some conventional loans can be secured with as little as 3% down, some lenders may require you to make a down payment of at least 20%. Government-backed loans, on the other hand, allow you to secure them with as little as zero down to 3.5%.
- You’ll typically need to pay monthly mortgage insurance premiums with a conventional loan if you put down less than 20%. It’s important to note that there are ways to work around this and opt for single premium or split premium MI. In these cases, the MI can be paid for upfront by the buyer, seller or lender. It can even be financed into the loan amount in some cases. USDA and VA loans do not have a monthly mortgage insurance requirement.
- Closing costs could be higher for a conventional loan than a government-backed loan.
Who qualifies for a conventional loan?
To be eligible for a conventional mortgage loan, you have to meet particular criteria that demonstrate your financial readiness.
“While credit score requirements may vary, a minimum credit score of around 620 is generally preferred. Aiming for a higher score can bring you better interest rates and terms,” explains Alex Shekhtman, CEO and founder of LBC Mortgage.Check your home buying options. Start here
Conventional loan lenders also look closely at your debt-to-income ratio (DTI), which measures how much of your income goes toward debt payments. You may not qualify for a conventional loan if your DTI is over 50%.
Additionally, conventional loan requirements vary across lenders. You may have the option to put down as little as 3%, but if you make a down payment of less than 20%, you will need to pay for private mortgage insurance
“Loan-to-value ratio (LTV) is a factor that lenders evaluate. A lower LTV ratio indicates less risk and showcases your financial stability – strengthening your chances of securing a conventional loan,” adds Shekhtman, who notes that the max LTV allowed for a conventional loan is 97% (which means you will need to put down at least 3%).
Why home sellers prefer conventional loans
There are several reasons why home sellers typically prefer to work with buyers who have conventional mortgage loan financing lined up over other types of financing.
“By offering greater flexibility in fewer restrictions, conventional loans can make the home sale process smoother and more efficient while also providing a sense of financial stability and responsibility on the part of the buyer,” says Adie Kriegstein, a licensed real estate salesperson for Compass Real Estate in New York City.Get preapproved for a mortgage. Start here
Reason #2? “Conventional loans often require higher down payments. A seller can view this as a sign of financial responsibility, which can give them greater confidence in the sale,” Kriegstein continues.
Consider that FHA, VA, and USDA loans may come with more stringent requirements and restrictions, which could make the seller concerned that the deal may not close as expected.
“For example, FHA loans require mortgage insurance premiums, which can increase the overall cost alone,” says Kriegstein. “VA loans may have specific rules around the condition of the property, which can limit the pool of potential buyers or it and USDA loans may only be available for properties in certain rural areas.”
Erica Davis, brand manager for Guild Mortgage in Myrtle Beach, South Carolina, agrees that conventional loans help put sellers at ease.
“When sellers put their home up for sale, they want to ensure that the deal will close quickly and without any unnecessary stress. With a conventional mortgage loan, the process is often more predictable. And conventional loans often come with more flexibility in terms of negotiating prices and contingencies,” says Davis.
Tips for non-conventional loan borrowers
If you can’t qualify for a conventional loan, you can always pursue government financing in the form of an FHA loan, VA loan, or USDA loan, provided you meet the specific eligibility criteria for each loan program.
Truth is, buyers with non-conventional loans can still find sellers who are willing to complete a home transaction with them – even though it may take longer, according to Patel.Check your home buying options. Start here
“If you have non-conventional financing, you can improve your chances of convincing a seller to work with you if you make a more serious offer on the house, one that shows that you are ready and intently interested in purchasing the property,” she suggests.
Additionally, “you should work to improve your credit score and save for a larger down payment if possible,” advises Kriegstein.
To improve your odds of getting a seller to accept your offer when a non-conventional loan is involved, “consult closely with a mortgage professional who can help you navigate the financing process,” Shekhtman recommends.
The bottom line
Assuming you qualify for a conventional mortgage loan, you’ll stand a better chance of choosing from a wider variety of homes for sale in various locations and convincing a seller to accept your offer.
But don’t despair if you’re not immediately eligible for conventional financing. Partner with a trusted lending expert who can guide you through the process and recommend alternative loan options tailored to your needs.Time to make a move? Let us find the right mortgage for you