“Conventional loans” are mortgages that are not guaranteed or insured by a government agency. In other words, the investor is assuming all the risk. Because of this, rates have trended a little higher than government insured loans like FHA or USDA loans. Additionally, the down payment required for a conventional loan has historically been a little higher at around 5%; however, there are some 3% down options available. In 2016, new conventional programs were introduced with a lower down payment to take back some the market share from FHA which only requires a minimum of 3.5% down. There are specific guidelines for these new programs and I can check if you’re qualified for a lower down payment loan option if you are interested.
Something important to remember when you are applying for a mortgage is that the down payment represents your actual initial ownership in the home. It represents your “skin in the game” should anything happen and you default on your loan. So if you put down 5%, the bank really owns 95% of your home when you close. Looking at it from this perspective you can better understand the bank’s risk if you are unable to make your mortgage payments for any reason. To mitigate this risk, the bank is going to require you to carry Mortgage Insurance for anything greater than an 80% loan to value (LTV). If you do not want mortgage insurance, then you have to be able to put down at least 20% of the sales price as a down payment. The good news with a conventional loan is that the mortgage insurance can go away once you reach the 80% LTV; however, on an FHA loan, the mortgage insurance is typically applied for the life of the loan.
Mortgages are investment vehicles for investors such as banks and other investors. Consequently, the institutions in the mortgage business want to be sure they can sell your mortgage as an investment at a later date. The majority of loans are sold in a bundle to another investor before you even make your first payment. Although this is not always the case, by thinking of your mortgage as an investment vehicle may help you understand lending guidelines. Conventional loans fall under “conforming” loan guidelines which typically include a lower Debt to Income (DTI) ratio threshold than some government loans. There are many other guidelines for conventional loans, but DTI tends to be the first major factor in determining if you qualify for a conventional mortgage. The second being your down payment, and the third your credit score. This is an oversimplification and not necessarily definitive, but these three factors are indeed fairly constant in determining how safe of an investment you are when compared to conforming lending guidelines. When you are being “pre-qualified” your loan officer is essentially determining what kind of loan you qualify for.