Conventional Loan Advantages & Disadvantages

A conventional loan is the most sought after mortgage option. This is not because it is the best loan. It has been viewed to be the best by most banks and mortgage companies in the past. Understanding what a conventional loan is will help you make the right choice.

A conventional home mortgage is any loan that follows Fannie Mae, Freddie Mac, or private label lending rules. This includes subprime, negative amortization ARM’s, jumbo, and interest only loans. Excluded from this lists are FHA, VA, USDA, business financing, and commercial loans.

Conventional mortgage loans offer advantages for some borrowers. One advantage is that there are no loan limit restrictions. This will not affect the average person.  If you are in the market for a home loan greater than about $800,000, this is your only real option.

Another advantage is the option of eliminating mortgage insurance and not having your taxes and insurance escrowed in your mortgage payment. This option is available only if you have a 20% equity stake. This is  not options with other types of mortgages. Although you will not pay mortgage insurance for the duration of the loan, there will be an insurance cost. You will not be allowed to pay your taxes and insurance on your own. These payments must be escrowed and included in your monthly mortgage payment.

If your income is not easily verified, conventional lending has alternatives that allow for limited or no documentation of income. You will need excellent credit and either a large down payment or a lot of equity due to the inherent risk to this type of loan. The interest rates are also higher due to this risk. Limited income, no income, or stated income loans are largely for a self employed borrower who receives no paystubs or W-2’s.

Conventional mortgages do carry some definite disadvantages. The major disadvantage is that the required equity stake is higher than on other residential loans. This means a purchaser will need to invest a greater down payment and someone looking to refinance will need a higher value vs. the loan amount requested. Credit underwriting is also stricter and current interest rates tend to be higher for those with average credit scores. The debt to income ratio is less flexible.

Understanding all of your options will help you choose the right mortgage for your needs and qualifications.


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