If you’re currently in the process of purchasing a home, you may have come across the terms “conventional” and “non-conventional.” But what’s the difference? And why should you choose one over the other?
A conventional loan is any type of mortgage that is not secured by a government-sponsored entity (GSE), such as the Federal Housing Administration (FHA) or the U.S. Department of Veterans Affairs (VA).
These loans are also known as “conforming loans” because they meet guidelines or “conform” to the rules set forth by Fannie Mae and Freddie Mac, the two largest investors of conventional loans. The rules they conform to include a minimum FICO requirement of 620, a loan amount not exceeding $417, 000 for a single-family home, and a debt-to-income (DTI) ratio not exceeding 36%.
DTI represents the amount of your monthly mortgage payments and other debts in comparison to your monthly gross income. Total debts usually can’t exceed 36% of your monthly gross income. In certain circumstances, you can have a DTI as high as 45%, but only if you meet Fannie and Freddie’s requirements, including exceptional credit history.
Additionally, conventional loans require a down payment of at least 20%. So if your loan amounts to $100, 000, you would need to put down $20, 000 plus any fees and closing costs upfront. If you’re not able to put down 20%, you’re required to buy private mortgage insurance (PMI).
There are two basic types of conventional loans:
- Adjustable rate: After an initial fixed-rate period, your interest rate can adjust up or down, depending on the market. This option can save you money if you plan to move or refinance within 5–10 years.
In the past, prospective homeowners were required to put down at least 5% for conventional loans, but a recent program now allows down payments as low as a 3%. With attractive interest rates and the option for a low down payment, a conventional loan is a great option for some buyers.
The other type of loan is called a non-conventional, or “government” loan. These loans are backed by the government, offering different and sometimes more flexible products for certain buyers. Depending on your financial situation, non-conventional loans can help you obtain a mortgage when you otherwise may not have met conventional guidelines.
There are two types of non-conventional loans:
- FHA: An FHA loan has less stringent qualifications and credit requirements than a conventional loan. You can put less than 20% down when purchasing. FHA loans, however, do require you to pay mortgage insurance premiums (MIP).
Whether you choose a loan product that is conventional or non-conventional, you should always discuss your options with your Home Loan Expert. Your individual situation will determine which loan option fits you best.
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