What Are The Pros And Cons Of Conventional Loans?

When shopping for a mortgage, you may be presented with several options for your home loan. The main types are government-backed loans such as Federal Housing Administration (FHA) and Veterans Affairs (VA) loans, and privately backed conventional loans.

If you’re new to the home buying process, you may want to weigh the pros and cons of each loan program to help you decide which option is the best fit for your home purchase. In today’s article, we’ll take a look at some of the pros and cons of conventional lending.

What Exactly Is A Conventional Loan?

A conventional loan is any kind of loan (such as a mortgage) available through a private lender. Conventional loans aren’t secured by government entities.

This means the bank is taking all the risk in loaning the money. If a person cannot pay the mortgage, it is up to the bank to sell the property and hope they can recover the money they loaned. If the property cannot be sold for enough to cover the loan amount, the bank will lose money on the sale.

It is important to note how this is different from a government backed loan, where the money is loaned by the bank, but the mortgage is insured by the US government. With a government loan, the bank will be repaid for its losses by the government in the event that a mortgage cannot be repaid by the borrower.

Pros Of A Conventional Loan

Lower Closing Costs

Conventional loans typically have lower closing costs when compared to other loan options. With FHA loans you have upfront mortgage insurance payments, while VA and USDA loans have funding fees. If you know you’ve got the money on hand to make your down payment, but don’t want to be hit by additional fees, then this aspect of a conventional loan may be highly appealing to you.

A Lower Or Even No Mortgage Insurance Payment Requirement

Generally speaking, if the down payment is smaller than 20% of the value of the home, you will be required by the bank to purchase mortgage insurance. This will automatically be added into the monthly mortgage payment.

The difference is that FHA and VA loans have mortgage insurance requirements that must be paid upfront. Conventional loans on the other hand have no upfront mortgage insurance cost, and the monthly insurance payment is typically smaller than a government loan depending on how much your down payment was and what your credit score is.

Second Home And Investment Properties

FHA and USDA loans have strict rules when it comes to the types of properties they can be used for, with both secondary and vacation homes, along with investment properties, being ineligible. So if you’re looking for a loan that will allow you to purchase a second home or an investment property then a conventional loan is the right loan type for you to pursue.

Down Payment Options Available From 3% And Up!

In days past, it used to be a requirement for the borrower to have a 20% down payment to obtain a conventional loan. These days the down payment on a conventional loan can be as little as 3% if you meet all the necessary requirements, but if you have a poor credit score, or issues with your finances, the rate might be slightly higher.

When compared to an FHA loan, the amount required as a down payment is quite similar. For example, let’s say you have a $200,000 mortgage. With an FHA loan, the down payment requirement is 3.5%, or $7,000 on a $200,000 loan. A conventional loan with a down payment of 3% is just $6,000, but you’ll need to make sure you qualify for it.

Cons Of A Conventional Loan

Tougher Credit And Income Requirements

Because the bank is taking all the risk in offering you a conventional loan they will be more strict in who they lend money to. The borrower will generally be required to have a higher credit score than FHA loan borrowers.

The lender will also require higher income or a lower debt-to-income ratio. The debt-to-income ratio simply means you take all your current monthly payments such as car, mortgage, credit card, and student loan payments and add them all up versus how much money you make before taxes. If the total payments are higher than a certain percentage of your income the lender may deny the loan. Whereas, with an FHA loan, they may allow up to 43%.

Conclusion

As you can see, when shopping for a mortgage there are various paths a borrower can take, they all have their positives and negatives. Take a look at our FHA vs. conventional loan comparison guide to continue exploring the differences between an FHA loan and a conventional loan. If you have more questions about the process or would like to get started please get in touch with one of our Loan Officers here at OVM Financial!