When you’re trying to buy a home for the first time, you will probably hear about FHA loans and conventional loans. FHA first-time home-buyer loans are a great way to buy your first house, even if you don’t have perfect credit or enough money to furnish a large down payment (or any down payment at all in some cases).
Typically banks are skittish about loaning to people whom they perceive as posing a high risk—like first-time buyers in these situations. Nonetheless, even getting an FHA loan can be a challenge. The alternative to FHA loans are conventional loans.
What is a conventional loan, and what are its terms and characteristics?
A conventional loan is not an FHA loan, but instead either a conforming or non-conforming (jumbo) loan. To understand what this means, you have to know about the Fannie Mae and Freddie Mac guidelines for conforming conventional loans. These two corporations are government sponsored bodies which set guidelines for lenders to residential home buyers.
Conforming loans don’t exceed the loan limits set by these two corporations. Non-conforming (jumbo) loans are used to finance particularly expensive properties and other unusual situations which call for more money to be loaned than would fit the loan limits.
Both conforming and non-conforming loans are conventional. They feature different interest rates, fees, and terms (usually the much higher interest rates and fees are charged by jumbo lenders). Every lender sets its own terms, so when you’re shopping for a conventional loan of any type you’ll need to shop around to find a good deal.
To get a conventional loan you will need to have some money to put down as a down payment, usually between 5-20%. You’ll also need to have a certain minimum credit score (at least 620, but the higher the better) and a steady income and a good income-to-debt ratio. If you don’t fit these guidelines, you’ll have a hard time getting a conventional loan, though some hard money lenders may still consider you to be worth the risk.
Conventional loans may have either fixed or adjustable interest rates. With a fixed rate, the rate you get when you sign the mortgage is the same rate you’ll have for the duration of the loan.
With an adjustable rate you’ll usually get a very low rate in the beginning, but after a set number of years your rate will be floated against the market index.
This means it may go higher or lower over the years depending on what happens with the housing market. There are pros and cons to each type of interest rate, and different situations where you might benefit from one more than another.
For example, if you only want to buy a home for a few years and then resell, an adjustable interest rate could save you money. If you plan to stay a long time though, you might want the certainty of a fixed rate.
Don’t yet qualify for a conventional loan or an FHA loan?
It may not be the best time for you to purchase your own home. Start working on your credit rating and your income-to-debt ratio—whatever you can do to make yourself look like less of a risk will make you much more appealing to lenders. It will also increase the likelihood that you’ll be able to afford to stay in your home for a long time.
If you do get a conventional loan, you won’t have FHA mortgage insurance. That being the case, be prepared to spend additional money each month on mortgage insurance. This is required by most lenders if you own less than 20% of your home. So if you place a down payment which is lower than that, you’ll need to take out the insurance. All of these are factors to consider when you decide to purchase a house.