Conventional loans involve any type of mortgage not backed by a government agency. They're designed to be accessible for most homebuyers but often have stricter down payment and credit requirements than government-backed loans like FHA & VA. If you're in the market for a mortgage, conventional loans are usually the first place to start before you explore other options.
What are the benefits of a conventional loan?
Conventional loans are the most common type of mortgage in the United States, which gives them a big advantage over government-backed loans since all types of funding institutions are familiar with them. They also have flexible loan terms, the highest lending limits of any mortgage product, and cancellable mortgage insurance after you meet a certain level of home equity.
However, many of the greatest benefits of conventional loans are only accessible if you have a certain credit profile. If you are currently below a 700 credit score, it may not be in your best interest to get a conventional loan, at least to start. Let’s take a look at the pros and cons of conventional loans so you can help determine if it’s right for you.
| Pros | Cons |
|---|---|
| Temporary Mortgage Insurance | Higher Interest Rates |
| Flexibility | Larger Down Payment Requirements |
| Higher Lending Limits | Stricter Eligibility Requirements |
Pro: Temporary PMI or None At All
One of the biggest benefits of conventional loans is their flexibility in terms of private mortgage insurance (PMI). This is an extra fee you'll pay on your monthly payment to offset the risk for your lender if you have less than 20% equity in your home. Government-backed loans, which are usually best for homebuyers with a low down payment, typically include mortgage insurance and may even require it for the full life of your loan, even after you've built up more than 20% equity.
Most conventional loans, on the other hand, will lower the cost of mortgage insurance if you put down more upfront. Plus, once you reach 22% of the home's appraised value, your PMI payment will usually automatically fall off.
Con: Higher Interest Rate
Although conventional loans can come with lower rates, this is generally only true if you have a high credit score. A lower credit score means more risk for your lender. Because of that, they'll charge you more to cover that risk, especially since a conventional loan doesn't have a government agency as a safety net. Once your score dips below 680, you typically find that government-backed options offer more competitive rates.
Pro: More Flexibility
Because conventional loans aren't backed by a government agency, lenders have more freedom to offer flexible options in terms of loan interest rates, terms and more. You'll have more freedom to choose whether you want fixed- or variable-rate financing, and you can typically avoid the extra cost of mortgage insurance if you put down a large enough amount (usually 20%).
With a government-backed loan, mortgage insurance is often included, and rate and term options may be more limited. Most government-backed loans also require that the home you purchase with the loan be your primary residence. A conventional loan allows you to avoid many of these restrictions.
Con: Larger Down Payment
While programs through Fannie Mae and Freddie Mac allow as little as 3% down, many conventional lenders require at least a 5–20% down payment.
Paddio allows 3%- 4.99% down payments on HomeReady and Home Possible conventional loans. All other conventional loans we offer require a down payment ranging from 5-10%, depending on your loan type, borrowing situation, and credit score.
Reach out to a Paddio loan expert today to see what down payment you qualify for.
Pro: Higher Lending Limits
The lack of government involvement also means you'll usually be able to access more funds with a conventional loan. The limit on an FHA loan, which is one type of government-backed loan, currently sits at $1,209,750 for high-cost areas. For a conventional loan, on the other hand, you may even be able to borrow up to $2 million in some markets if your credit score is high enough.
If you’re looking for a particularly large loan amount, you can also seek a jumbo loan, which is available for conventional loans and government-backed loans.
It's important to note that conventional loans fall into two categories: conforming and non-conforming. Your loan limit will differ depending on which type you are seeking.
Regardless of your loan type, your loan limit will depend on what you can afford.
Con: Stricter Eligibility Requirements
On the other hand, most conventional loans have stricter eligibility requirements than government-backed loans.
Although the process for government-backed loans may take longer and involve more third parties, that doesn't mean securing a conventional loan is a walk in the park. Your lender is counting solely on you to ensure the loan is repaid, so they'll scour your financial history in greater detail to ensure you'll be a reliable borrower.
Additionally, if you have any major red flags in your financial past, you will need to wait longer to apply for a conventional loan than you would a government-backed loan.
After bankruptcy, you typically must wait 4 years before getting a conventional loan and 7 years after foreclosure. Meanwhile, FHA loans only require 2 years after bankruptcy and 3 after foreclosure.
Weighing Conventional Loan Pros and Cons
Is a conventional loan right for you? It depends. Conventional loans have many advantages. If you have a high credit score, a conventional loan is likely the best choice to give you access to the best rates and the most flexible loan terms on the market. For buyers with lower scores or less cash to bring to the table, though, it's worth exploring government-backed loan options.
