Conventional vs Non-Conventional Loans Roger Odoardi Even if you are just starting out on the journey to homeownership, it is likely that you have heard about two of the most common mortgages: conventional and nonconventional. A conventional loan or mortgage is not backed by the government, whereas a non-conventional loan or mortgage is. Depending on your specific situation as a buyer, each of these mortgages will provide you with different advantages and disadvantages. Wondering which option is right for you? In this guide, we cover the differences between conventional and non-conventional mortgages. What is a Conventional Mortgage? Conventional mortgages are the most common type of loan, accounting for 60% of all mortgage applications. As private-sector loans that are not government-backed but follow guidelines set by Fannie Mae and Freddie Mac, there is no guarantee to the lender if a borrower defaults and thus the requirements are known to be stricter. In general, a conventional mortgage is ideal for borrowers with good credit that can provide a larger down payment. Conventional loans are more affordable in the long run and can be a smart investment for your future. There are two types of conventional mortgages: fixed rate and adjustable rate. Fixed vs. Adjustable-Rate Mortgages Fixed Rate Mortgages Fixed rate mortgages maintain a fixed interest rate for the life of the loan. This mortgage option offers predictable payments and is ideal for buyers that intend to stay in their home for a long time. With fixed rate, borrowers can choose between 15-year, 20-year and 30-year mortgages. Note that the shorter the loan period, the lower the interest rate but the higher the monthly payments will be. Adjustable Rate Mortgages Also known as a variable rate or tracker mortgage, an adjustable rate mortgage is a mortgage with a convertible interest rate. This mortgage option will allow a buyer to start out with a lower monthly payment, however after an initial fixed period of 3 to 10 years, that rate can be adjusted yearly based on the performance of an index. Note that rate caps will prevent the interest rate from going up or down past a certain point. An adjustable rate mortgage is a good option if you need a lower monthly payment to get started and you don’t mind the unpredictability of a fluctuating interest rate in the future. What is a Non-Conventional Mortgage? Non-conventional mortgages are designed to help individuals with low to moderate incomes or individuals that require a low or no down payment. This type of loan caters to borrowers who may have been rejected for a conventional loan. Reasons a borrower may have been rejected could include the following: Being self-employed Unsteady employment history History of bankruptcy Insufficient cash reserves One downside to non-conventional loans is that they will require the borrower to pay additional fees, including mortgage insurance premium (MIP), funding and guarantee fees. Conventional Loan Examples There are two main types of conventional loans: conforming loans and non-conforming loans. Conforming Loans Conforming loans refer to any conventional mortgage that adheres to the financing limits set by the Federal Housing Finance Agency (FHFA). This loan type additionally meets the standards to be bought by Fannie Mae and Freddie Mac, including that it must meet the loan limit based on that area. Presently, the maximum loan limit in most U.S. counties is $417,000. Non-Conforming Loans Also known as jumbo loans, non-conforming loans are loans that exceed the FHFA’s conventional mortgage financing limits. They generally have higher interest rates and higher down payments than conforming loans. In addition to conforming and non-conforming loans, there are existing programs such as HomeReady and HomePossible by Fannie Mae and Freddie Mac. There are also many conventional loan options that are specific to each state, so be sure to ask your realtor or mortgage broker about any additional options that exist where you are looking to buy. Non-Conventional Loan Examples When it comes to non-conventional loans, there is a much wider variety in the options that are available to home buyers. FHA Loans A type of low down payment government loan insured by the Federal Housing Administration, a program office of the U.S. Department of Housing and Urban Development. FHA loans are ideal for borrowers who do not have a lot of cash for a down payment or that have a low credit score. VA Loans A loan provided by a private lender and guaranteed by the U.S. Department of Veterans Affairs to make homeownership more affordable for veterans. VA loans can be used to buy or refinance a home. USDA Loans A type of government loan insured by the U.S. Department of Agriculture’s Rural Housing Program that enables low- and moderate-income households to purchase property in eligible rural areas. Benefits include zero down payment required and easy qualifications. HUD Section 184 A loan option with low down payment and no minimum credit score that is guaranteed by HUD’s Office of Native American Programs in an effort to make homeownership more affordable for Native Americans. The guarantee of the loan assures the lender that in the event of foreclosure, its investment will be repaid in full. What Do I Need to Qualify for Conventional vs. Non-Conventional Loans? Qualifying for either a conventional or non-conventional loan comes with a significant amount of verification. In general, the qualifications for each loan type will be as follows: Conventional Mortgage Loan Requirements The following factors must be taken into consideration when applying for a conventional mortgage loan: Credit score: The minimum credit score to qualify for a conventional mortgage ranges from 620 to 640, depending on the lender. Documentation: Lenders will require you to provide documentation that verifies your income, your ability to pay debts, as well as your spending habits. Income and assets: Lenders will use your bank and investment account statements to verify that you have sufficient means to cover the down payment and closing costs. Minimum Down Payments: Most lenders will require 5% down but it could be up to 20%. Some states such as Maine, New Hampshire and Massachusetts offer options that allow for 3% down. Property Eligibility Type: Almost any type of property can qualify to use a conventional mortgage, including warrantable condos, modular homes and multifamily residences. Sufficient DTI Ratio: Most lenders will permit a maximum debt-to-income ratio of 43%. Private Mortgage Insurance (PMI): Any borrower that qualifies for a conventional mortgage and pays less than 20% down will be required to pay PMI. PMI for a conventional loan typically costs between 0.5% and 1% of the entire loan on an annual basis. Non-Conventional Loan Requirements When it comes to non-conventional mortgages, the requirements will vary by loan type. Below is a breakdown of the differing requirements. VA Loans: VA loans are only available to veterans or qualifying family members. FHA Loans: Require a credit score of at least 580, a minimum down payment of 3.5% and MIP on the life of the loan if you put less than 10% down. USDA Loans: Requirements include that income limits that vary by city and state and that borrower must pay the guarantee fee. Additionally, lenders will consider the income of everyone in the household, not just the borrower. Which Loan Type is Right for Me? Wondering how to decide which option is right for you? Start by going through the list below and checking off which boxes sound the most fitting to your unique financial and borrowing situation. When to Choose a Conventional vs. Non-Conventional Mortgage Conventional Non-Conventional You can afford a larger down payment You require a lower down payment You have a high credit score You have less than perfect credit Your DTI is low Your DTI is high You have sufficient cash reserves You have a history of bankruptcy Benefits of Conventional Loan: No upfront mortgage insurance Potential for lower mortgage insurance rates or no mortgage insurance at all Stable interest rates More appealing to sellers Viewed as less risky for lenders Shorter underwriter approval process No extra fees Benefits of Non-Conventional Loan: Require little to no down payment Can still qualify with poor credit Wide array of options With the numerous different loan types that are available today, it is best to speak with an experienced mortgage broker before you start applying to ensure that you are heading the right direction. Contact us today to start a conversation about how Blue Water can assist you in finding a mortgage that best fits your needs. Blue Water Mortgage is licensed in New Hampshire, Maine, Massachusetts, Connecticut, Florida and North Carolina. Roger Odoardi Roger is an owner and licensed Loan Officer at the Blue Water Mortgage office in Hampton, NH. Roger graduated from the University of New Hampshire Whittemore School of Business and has been in the mortgage industry for over 20 years. Roger has originated over 2500 residential loans and is licensed in New Hampshire, Massachusetts, Maine, Connecticut and Florida.