Pros and Cons of a Conventional Loan

Aug 2, 2023 | Mortgage Guides

Conventional Loans: Weighing the Benefits and Drawbacks

A conventional loan is a mortgage that the government does not insure. This means the lender assumes more risk, and as a result, they have higher interest rates. However, conventional loans also have some advantages, such as being easier to qualify for and having more flexible terms. 

This article will discuss the pros and cons of conventional loans to help you decide if this type of mortgage is appropriate.

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Pros of Conventional Loans 

Competitive Interest Rates: 

When determining interest rates, lenders consider factors such as credit score, debt-to-income ratio, and loan-to-value ratio. Borrowers with excellent credit can secure better rates, resulting in potential savings on interest.

Flexibility 

Conventional loans offer more flexibility regarding loan terms and down payments. Borrowers can choose from fixed-rate and adjustable-rate mortgage options. In addition, some allow down payments as low as 3% to 5% of the home’s purchase price.

No Mortgage Insurance with Sufficient Down Payment 

If borrowers can put down at least 20% of the home’s purchase price, they avoid the cost of private mortgage insurance (PMI). Circumventing PMI reduces mortgage payments.

Availability for Various Property Types

Conventional loans can finance diverse types of properties:

  • Primary Residences: For purchasing single-family homes, townhouses, and condominiums that will serve as the borrower’s primary residence.
  • Second Homes: Finance purchases to buy a vacation home or a second property.
  • Investment Properties: To finance rental or investment properties intended to generate income or be held for capital appreciation.
  • Multi-Unit Properties: Finance properties with multiple units, such as duplexes, triplexes, and fourplexes. The number of units allowed may depend on the lender’s guidelines.

Cons of Conventional Loans

Stricter Eligibility Requirements: 

Conventional loans often have more stringent criteria compared to government-backed loans. Lenders require higher credit scores, lower debt-to-income ratios, and a more substantial down payment. This can make it challenging for some borrowers, especially those with less-than-perfect credit or limited funds for a down payment, to qualify for a conventional loan.

Private Mortgage Insurance (PMI): 

If a borrower puts down less than 20% of the home’s purchase price, conventional loans require private mortgage insurance (PMI). PMI is an additional cost that protects the lender in case the borrower defaults. While PMI allows borrowers to get a loan with a smaller down payment, it adds to the overall cost.

Potentially Higher Costs: 

Conventional loans may have higher interest rates and closing costs. Borrowers with less-than-perfect credit may be offered less favorable interest rates, which can increase the total cost of borrowing over the life of the loan.

Limited Assistance Programs:

Conventional loans do not offer specialized assistance programs for first-time homebuyers or military veterans. Government programs often provide additional benefits, like down payment assistance or more lenient credit requirements.

Appraisal: 

Conventional loans require a property appraisal. If the value is lower than the agreed-upon price, the borrower may need to cover the difference in cash or renegotiate the terms. This can lead to potential delays or difficulties in completing the transaction.

Comparison with Other Loan Types

Conventional loans are the most common mortgage in the United States. They are regulated by Fannie Mae and Freddie Mac, government-sponsored enterprises (GSEs). Conventional loans have strict eligibility requirements but offer lower interest rates and more flexible terms.

Other loan types include government-backed loans, such as FHA, VA, and jumbo loans. Government-backed loans have more relaxed eligibility requirements but have higher interest rates and less flexible terms. Jumbo loans are larger than conventional loans and are not backed by the government. They have higher interest rates and stricter eligibility requirements than conventional loans.

Below is a table that summarizes the differences:

Conventional Loan Mortgage Rates | Wesley Mortgage

Fees and Costs Associated with Conventional Loans

The fees and costs depend on the lender, the type of loan, and the property. Compare different lenders to get the best deal. Here are some additional details:

  • Application Fee: Charged by the lender to cover the costs of processing your loan application. The amount can vary depending on the lender.
  • Appraisal Fee: To determine the value of the property. The amount is based on the appraised value.
  • Title insurance: Protects the lender against problems with the title to the property. The buyer pays the cost.
  • Survey fee: To map the property and ensure no encroachments. The buyer pays the cost
  • Homeowners insurance: Protects you and your property from damage or loss. The homeowner pays the insurance.
  • Private mortgage insurance (PMI): Protects the lender in case you default on your loan. PMI is required if you make a down payment of less than 20%. The borrower pays the PMI.
  • Interest: Paid to the lender for borrowing money. The interest rate on a conventional loan depends on the lender, the type of loan, and the borrower’s credit score.
  • Closing costs: These are associated with closing the loan, such as attorney, title, and recording fees. Depending on the terms of the sale, the buyer and the seller pay the closing costs. 

Tips for Obtaining a Conventional Loan 

The following tips will help you navigate the process:

Tip #1: Check and Improve Your Credit Score: 

The credit score plays a significant role in determining eligibility and interest rate. Before applying, obtain a copy of your credit report from the major credit bureaus and review it for discrepancies. If your credit score needs improvement, take steps to boost it, such as paying off debts, keeping credit card balances low, and making payments on time. 

Tip #2: Save for a Down Payment: 

Aim to save at least 20% of the home’s purchase price to avoid private mortgage insurance (PMI) and demonstrate financial stability. If a 20% down payment is not feasible, reduce the amount you need to borrow and mitigate the impact of PMI.

Tip #3: Gather and Organize Financial Documents: 

Lenders require various documents to assess your eligibility. These include pay stubs, W-2 forms, tax returns, bank statements, and other relevant income or asset documentation. Organizing these files in advance can expedite the process and demonstrate your financial readiness.

Tip #4: Compare Offers: 

Lenders may offer varying interest rates, loan terms, and closing costs. Take the time to obtain loan estimates from multiple lenders. Pay attention to the interest rate, loan costs, and fees. 

Bonus Tip: Consider Pre-approval 

Getting pre-approved can give you an idea of how much you can borrow and what you can afford. Pre-approval involves a lender reviewing your financial information and issuing a conditional commitment. A pre-approval letter can make you a more attractive buyer and streamline home-buying.

The conventional loan application process may depend on your situation and the lender’s policies. Working with a knowledgeable loan officer is beneficial, as they can guide you through the process and provide personalized advice.

Conclusion 

Getting a conventional loan depends on your financial situation and goals. On the one hand, it offers flexibility in loan amount and repayment terms and lower interest rates. On the other hand, it requires a higher credit score and a larger down payment. Alas, weighing the pros and cons of a conventional loan and considering other options before deciding is essential.

To learn more about conventional loans and other mortgage options, contact Wesley Mortgage today!

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888.407.2102 | info@wesleymortgage.com

As the Official Mortgage Provider of The Tennessee Titans, Wesley Mortgage turns home ownership dreams into reality thanks to our exemplary customer service, expedited closing times, and reinvestments back in to Middle Tennessee. It’s the mortgage that does more; more for you and more for your community.

Known for “Doing All The Good You Can,” local lender, Wesley Mortgage, lives up to that promise. The founder, Chuck McDowell, is a Middle Tennessee native who has witnessed this area’s massive growth in recent years. As a successful entrepreneur with over 30 years of business experience, Chuck created Wesley Mortgage as a company designed from the ground up to give back to the people and organizations that make Nashville great

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