A conventional loan is the most common form of mortgage in the U.S market. Conventional mortgages get it's name from the fact that they are not insured by any government agency as opposed to FHA loans and VA which are guaranteed by HUD and Veterans’ Administration respectively.
Most of the conventional loans in the U.S are Fixed Rate Mortgages where the interest rate is fixed for the entire term of the loan(generally thirty years). There are also Adjustable Rate Mortgages where the interest rate fluctuates on par with a predefined index. See the Federal Reserve Board site for more information on ARMs and FRMs.
Most conventional loans, also called traditional loans, are packaged into mortgage-backed securities and sold in to secondary market. Since Fannie Mae and Freddie Mac control about ninety percent of the nation's secondary mortgage market, the terms and conditions of the traditional loans should meet the funding criteria set by Fannie Mae and Freddie Mac.
Why Take a Conventional Loan?
There are many alternatives to conventional loans, for example government insured loans like VA and FHA loans, but generally for a borrower with good credit history, a traditional loan offers the lowest interest rates. Another interesting point is that although conventional loans insist on a 20% down payment, putting down more equity on his home may actually be beneficial to the borrower.
In the housing bubble of 2000 to 2006 a lot of home buyers took out loans with zero or very low down payment. When the bubble burst and housing prices started going down, these home owners were left with zero(sometimes negative) equity in their homes. With little or no equity, they could not refinance or sell their homes and most of them had to opt for foreclosure. Thus a 20% down payment is the best insurance against a decline in home prices.
Conventional Vs FHA Loans
Traditional loans require a 20% down payment but FHA loans allow a minimum down payment of 3.5%. Another difference is that while traditional loans depend heavily on the credit score of a borrower for determining the interest rate, lenders of FHA loans are more concerned about the ability of a borrower to repay his mortgage. FHA loans are suited for first-time home buyers who often does not have enough resources for the 20% down payment. The guidelines on FHA loans are more lenient than those for conventional mortgages. Read more about the differences between conventional and FHA loans here.
Conventional Vs VA Loans
VA loans are available to for veterans and members of the military. Borrowers who qualifies for the VA loan program can put down as little as zero percent down payment. Since the Department of Veterans Affairs guarantees the loan, there is no need for private mortgage insurance and the qualifying terms for VA loans are not as stringent as those for conventional loans. See the Veteran Affairs web site for more information on V.A loans.
When choosing a mortgage, a borrower is advised to weigh the advantages and disadvantages of each type of loan and choose what is best for him. A borrower with a good credit history and enough cash for 20% down payment can get the lowest interest rates with a conventional loan. Even if the borrower doesn't have the 20% down payment, he can still take a conventional loan with private mortgage insurance.
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