What is a Conventional Loan?

Most lenders would consider a conventional mortgage as a loan that conforms to the guidelines set forth by Freddie Mac and Fannie Mae, the two government-sponsored enterprises (GSEs) that provide liquidity in the mortgage market. It is a loan that is not guaranteed or insured by the US government, such as VA, FHA, and USDA loans are.

Conventional mortgages include portfolio loans, construction loans, and even subprime loans. Whenever a lender refers to a “conventional loan,” they are most likely referring to conforming mortgage loans that are eligible for purchase by Fannie Mae and Freddie Mac. The exception is in the case of a “jumbo” loan which is conventional, but non-conforming because it exceeds the loan limits for the area in which the home is located.

The maximum limit for a conforming loan depends on the county and state you live in and can be found here: Fannie Mae Loan Limits.

A conventional mortgage can have an interest rate that is either fixed or adjustable. In other words, the rate is either the same (or fixed) for the life of the loan or it is fixed for a certain period (such as 3 years, 5 years, or 7 years, etc.) and then can adjust up or down depending on what the terms of the loan call for and the “index” rate that the loan is based upon. You should note that as the interest rate moves up or down, so will the payment.

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Why a Conventional Loan?

There are several reasons why a buyer would need a conventional loan and a few where it makes more sense to use a conventional loan product. A few reasons are listed below.

Conventional loans are required for:

• Investment loans / rental properties
• Second homes / vacation properties
• Homes that are priced above the FHA loan limits and/or would require a jumbo loan
• Borrowers who do not want to escrow their tax and insurance payments each month

Conventional loans may be a better fit for:

• Borrowers who have a large downpayment. Loans with more than 20% down do not require Private Mortgage Insurance, but downpayments can be as low as just 3%.
• Borrowers who have an existing government-backed mortgage and would like to purchase another home
• Borrowers who have very high credit scores and do not want to pay PMI for a long period like is required with an FHA loan

It is also important to keep in mind that conventional loan programs are not as friendly to those borrowers who have had a bankruptcy in the last two years or a foreclosure in the last 3 years. In that case, FHA may be a better option.

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Who Are Fannie and Freddie?

These publicly traded companies and Government Sponsored Enterprises (GSEs) are the largest sources of mortgage money in the United States.

Fannie and Freddie provide that liquidity needed by purchasing the mortgages, bundling them with thousands of other similar loans, and selling them as bonds on the mortgage-backed securities market.

What Type Of Mortgages Do Fannie Mae and Freddie Mac Purchase?

1. They must meet the conforming loan limit which is evaluated every year
2. Loans with borrowers who have a minimum credit score
3. It meets the GSE guidelines in regards to debt-to-income ratios
4.  Private Mortgage Insurance (PMI) is required for all loans where the borrower has less than 20% equity
5. Other guidelines apply

It is important to understand that neither Freddie Mac nor Fannie Mae services the loans they purchase. The lender usually services the loans that Fannie and Freddie purchase, simply meaning that they collect the payments and then distribute the proceeds to the “owners” of the mortgages.

If you are not sure if this is the right loan for you, or you need information on your loan options, feel free to contact us at 219-695-0369 or scott@nwiloanguy.com.