What is a Conventional Loan?
A conventional loan is a mortgage that is not backed by any government entity such as the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), or the USDA Rural Housing Service. Instead, conventional loans are underwritten following the guidelines set by private lenders or entities such as Fannie Mae and Freddie Mac.
Conventional loans typically have stricter credit requirements and call for a higher down payment than government-backed loans. They also come with fixed or adjustable interest rates.
Key Characteristics of Conventional Loans
- Credit Requirements: Borrowers usually need to have a higher credit score to qualify.
- Down Payment: Typically requires a down payment of at least 5-20%, although it can vary.
- Private Mortgage Insurance (PMI): Required if the down payment is less than 20% of the home’s value.
- Fixed-Rate Terms: Many conventional loans come with fixed interest rates and terms.
Examples of Conventional Loans
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Fixed-Rate Mortgage:
Abel applies for a 30-year conventional fixed-rate mortgage from his Savings and Loan Association. This loan locks in a stable interest rate and principal/interest payment for the life of the loan.
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Private Mortgage Insurance (PMI):
If Abel wishes to borrow more than 80% of the value of the property, he will need to purchase Private Mortgage Insurance (PMI), which protects the lender in case of default.
Frequently Asked Questions (FAQs)
What credit score is needed for a conventional loan?
Typically, a credit score of at least 620 is required, but higher scores will generally qualify for better interest rates.
Do conventional loans require a down payment?
Yes, most conventional loans require a down payment of at least 5%, although 20% is often recommended to avoid having to pay PMI.
How long are the terms for conventional loans?
Conventional loan terms can range from 10 to 30 years, with 15- and 30-year loans being the most common.
Is there a debt-to-income ratio requirement?
Yes, lenders usually look for a debt-to-income ratio below 43% for conventional loans.
- Fixed-Rate Mortgage: A mortgage with a set interest rate and fixed monthly payments over the life of the loan.
- Private Mortgage Insurance (PMI): Insurance required for conventional loans with loan-to-value ratios above 80%.
- Adjustable-Rate Mortgage (ARM): A loan with an interest rate that can change periodically based on the performance of a specific benchmark.
- Jumbo Loan: A conventional loan that exceeds the conforming loan limits set by Fannie Mae and Freddie Mac.
Online Resources
References
Suggested Books for Further Studies
- Mortgage Management for Dummies by Eric Tyson and Robert S. Griswold
- The Mortgage Encyclopedia by Jack Guttentag
- Your Mortgage: How to Save Real Money on Your Home Loan by Robert Irwin
Real Estate Basics: Conventional Loan Fundamentals Quiz
### What is a conventional loan not backed by?
- [ ] The borrower’s savings account
- [x] Any government entity such as FHA or VA
- [ ] The state government
- [ ] Corporate sponsorship
> **Explanation:** A conventional loan is not backed by any government entity like the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA); it is issued by private lenders according to their own guidelines.
### What is typically required if a down payment of less than 20% is given on a conventional loan?
- [ ] Additional credit inquiries
- [ ] Higher interest rates
- [x] Private Mortgage Insurance (PMI)
- [ ] Immediate refinancing
> **Explanation:** If the down payment is less than 20%, the borrower will generally be required to purchase Private Mortgage Insurance (PMI) to protect the lender in the case of default.
### What type of interest rate can a conventional loan have?
- [x] Fixed or adjustable
- [ ] Only fixed
- [ ] Only adjustable
- [ ] Variable only
> **Explanation:** Conventional loans can have either fixed or adjustable interest rates, depending on the terms agreed upon at the origination of the loan.
### What is the usual range for loan terms in conventional mortgages?
- [ ] 2 to 5 years
- [x] 10 to 30 years
- [ ] 5 to 15 years
- [ ] Only 30 years
> **Explanation:** Conventional mortgage terms usually range from 10 to 30 years, with 15- and 30-year terms being the most popular.
### Which additional requirement might affect primary borrowers with lower than required down payments?
- [ ] Tax deductions
- [ ] Government subsidies
- [x] Private Mortgage Insurance (PMI)
- [ ] Reduced loan amounts
> **Explanation:** Primary borrowers with down payments lower than 20% are usually required to purchase Private Mortgage Insurance (PMI), which mitigates the risk for lenders.
### What credit score is generally needed to qualify for a conventional loan?
- [ ] 500
- [ ] 550
- [x] 620
- [ ] 680
> **Explanation:** Typically, a credit score of at least 620 is required to qualify for a conventional loan, though higher scores can offer better terms.
### What type of debt-to-income ratio do lenders generally prefer for conventional loans?
- [ ] Less than 50%
- [ ] Over 50%
- [x] Less than 43%
- [ ] Exactly 45%
> **Explanation:** Lenders usually prefer a debt-to-income ratio below 43% for conventional loans to ensure the borrower can manage their monthly payments.
### Which type of mortgage often comes with a fixed principal and interest payment over its term?
- [ ] Adjustable-Rate Mortgage (ARM)
- [ ] Interest-Only Mortgage
- [x] Fixed-Rate Mortgage
- [ ] Balloon Mortgage
> **Explanation:** A fixed-rate mortgage provides stable and predictable payments by maintaining a consistent principal and interest rate over the life of the loan.
### What does required Private Mortgage Insurance (PMI) protect?
- [ ] The buyer’s credit score
- [ ] Increase in property value
- [x] The lender in case of borrower’s default
- [ ] Future refinance rates
> **Explanation:** Private Mortgage Insurance (PMI) protects the lender in the case of borrower default on loans where the down payment is less than 20% of the property value.
### Over what type of payment term length are interest and principal payments spread out for fixed-rate mortgages?
- [ ] Payments vary greatly
- [ ] Constant monthly payments against remaining loan balance
- [x] Fixed payment term
- [ ] Annual payments
> **Explanation:** In fixed-rate mortgages, interest and principal payments are spread out evenly over the term length, providing very predictable monthly payments for borrowers.
