Shopping for a mortgage should be your first step before you even begin to ponder your housing options. Whether you choose to go with an FHA, VA, USDA, Conventional or exotic mortgage is a very personal decision that you’ll have to make on your own, but I thought it might help if I made some useful lists about your favorite types of mortgages, including this one.
Conventional mortgages aren’t for everybody, but if you’ve got an excellent credit score, little debt and some assets or savings, they can offer a number of advantages to home buyers. Here are the ten reasons I think are the most important for choosing a Conventional mortgage, but make sure to ask your loan officer for their opinion, too.
1. Conventional Loans are Less Frightening to Home Sellers. Believe it or not, the kind of loan that you’re buying home with can influence both the final sales price and whether or not you’ll win in a competitive bidding situation. When a seller is faced with choosing between navigating a loan that can be problematic or complex, like an FHA loan, or one that’s straight-forward and closes quickly, their agent will always advise them to take the easy road.
Even if you’re sure there’s nothing wrong with the house you’re trying to purchase with an FHA loan, the seller has already heard a million horror stories from their friends about the odd FHA appraiser or home inspector who found or did something that killed their deal. A Conventional loan, on the other hand, leaves no one waiting for the other shoe to drop, so once you’ve decided what you want fixed from the home inspection, the sellers can safely assume there won’t be any more surprises.
2. Nearly Universal Servicing. FHA, VA and USDA have some very strict requirements of the banks they work with, which means that some banks won’t or can’t offer these programs. Conventional loans, on the other hand, are nearly universal — in fact, they’re also very flexible, allowing many banks to bend certain rules as they see fit.
Because a Conventional loan isn’t secured by government funds, the rules allow for a lot more servicers and more competition in the market. If you shop an FHA loan, for example, you’re going to find nearly identical pricing from bank to bank, but a Conventional loan may have very different fees. So, not only can your favorite bank service your Conventional loan, you might also be able to negotiate your closing costs down.
3. Fewer Steps to Closing. Other types of loans require extra steps in the underwriting process, whether those are checking your eligibility for limited participation programs, verifying and re-verifying funds or sending out special appraisers and inspectors. Every extra step and every extra spoon in the pot means more days to closing and more costs that stack up before closing. Conventional loans are nice, simple products that can get you to closing faster.
4. More Flexible Qualifications. Don’t let me confuse you, conforming Conventional loans require a higher credit score than other products. However, there are a number of liberties that a lender can take to overcome individual hurdles, from bankruptcies less than four years of age to medical debt. Requesting a manual underwrite can increase the time your Conventional loan takes to process, but it can turn a firm automatic denial into a manual approval if you were otherwise on the cusp of funding.
There’s also the other side of this coin — not all Conventional loans have to be conforming. That means that the lender doesn’t have to make your loan according to Fannie Mae’s guidelines. Although there’s a much smaller market for these loans today, they were once the most responsible arm of sub-prime lending. Rates are higher on non-conforming Conventional loans, but they’re a fixed-rate alternative to temporary measures like adjustable rate mortgages.
5. Less Costly Mortgage Insurance. When it comes to conforming Conventional loans versus their main competitor, the FHA loan, you’re going to spend a heck of a lot less on mortgage insurance. Between FHA’s upfront cost of 1.75 percent of the note’s value and the ongoing FHA mortgage insurance of .80 to .85 percent annually, you’re paying a whole lot extra for mortgage insurance, even if all other things are equal.
If you had a 720 FICO and were considering a $200,000 mortgage with a 10 percent down payment, for example, your mortgage insurance on a conventional loan would only cost you .44 percent annually, or a one-time payment of 1.81 percent of the loan’s value. Let me put all that together for you in a chart.
|FHA Total MI (Upfront plus monthly)||Conventional Monthly MI||Conventional Upfront MI|
|MI Payments||132 (minimum)||123||1|
|Rate||1.75% + 0.80% annual||0.44% annual||1.81% upfront|
|Total at 5 yrs||$11,136.97||$4,200.33||$3,630.00|
|Total at 10 yrs||$17,929.52||$7,936.23||$3,630.00|
Mortgage Insurance: FHA vs. Conventional ($200k loan @ 4% with 10% down) for borrower with 720 FICO Score
So, if you’ve kept the same loan for the requisite 132 months to shake your FHA mortgage insurance, you’d end up paying over $11,000 more than you would with a monthly mortgage premium on a conventional loan. The savings are even more dramatic if you brought less than 10 percent to the table — in these cases, FHA now requires mortgage insurance for the life of the loan.
6. Mortgage Insurance Flexibility. Unlike other types of loans that have only one way to pay your mortgage insurance: up front, throughout the loan or both (depending on the program), Conventional loans let you decide how you want to handle it. Currently, you can choose to pay all your mortgage insurance up front in one lump sum at closing (depending on your credit, that’s about 1.81 percent of the loan amount) or you can pay a little each month until your loan reaches a 78 percent loan to value ratio.
7. Automatic Mortgage Insurance Termination at 78 percent LTV. It’s a common belief that all types of mortgage insurance automatically drop at 78 percent LTV (as in the case of Conventional Loan), but that’s not really true. FHA loans made after April 2013 may have mortgage insurance for the lifetime of the loan, for example. Even those loans that are eligible for mortgage insurance cancellation often require you make a written request to the loan servicer to drop the mortgage insurance before they’ll actually do it, which may cost you extra and unnecessary premiums.
8. Lower Closing Costs. A conforming Conventional mortgage is a beautiful thing at the closing table. Since they’re easy to prepare, have few requirements besides a sufficient appraisal and don’t require upfront mortgage insurance (though you can opt for it), the closing costs on a Conventional loan are significantly lower than that of an FHA loan.
Beware shady lenders who will increase your fees by adding points or hefty origination fees, though. These guys can drive your closing costs up over the moon if you don’t watch them closely. When you’re shopping for a Conventional loan, make sure to get a Good Faith Estimate. It’ll include all estimated closing costs so you can compare fees between lenders. And you absolutely should shop around.
9. No Penalties for Low Down Payments. Fannie Mae reintroduced the 97 percent LTV loan to the Conventional mortgage loan arsenal in December 2014. This program is limited to first time home buyers, but there are 95 percent LTV options for everybody. Regardless of the low down payment option you choose, though, there’s no added penalty for being cash poor. That means no added fees beyond those typical to this loan type.
The biggest competitor in the low down payment market, FHA, has decided to penalize any buyers with less than a 10 percent down payment by implementing mortgage insurance for the life of the loan. In the past (and in the case of all Conventional mortgages), mortgage insurance was limited to the period when the value of the home was above 78 percent of the loan.
10. Piggyback Options. If you really don’t want to deal with mortgage insurance at all, Conventional loans will allow you to opt out of the system, in a way. Instead of financing a single mortgage for your home, you can take out two loans — one for 80 percent of the value of your new house and the other for 10 to 15 percent of the value (depending on your down payment). You’re still mortgaging your home, but instead of paying mortgage insurance, you’ve got a second loan with a slightly higher interest rate.
For some people, this configuration makes sense, especially if their credit rating is such that they’re right on the line between decent mortgage insurance rates and dastardly ones. Other buyers just don’t want to deal with mortgage insurance, period — and with the piggyback option they don’t have to. If you decide to secure a mortgage with a piggyback second to finance your home, you’ll sign both sets of loan documents at closing and may pay slightly higher closing costs because of the extra work involved.
The Bottom Line: Conventional Mortgages are Great Options for Those Who Qualify
I actually wrote 11 reasons to choose a Conventional mortgage — because I do honestly believe in these products. They’re not the easiest to qualify for, but if you can get one through a good lender, they will be easy and stress free. And everybody likes that. So, last, but not least, the arguably best reason to choose one of these loans: it’s easier to build equity with these products.
Think about it — having less mortgage insurance and fewer fees frees up some of the money in your wallet so you can contribute a little extra each month to the principal on your loan, which we all know shortens the lifespan of your mortgage. Even if you choose to not pay your loan down by adding a few dollars to your payment each month, the fact that you didn’t finance your upfront mortgage insurance and other fees means that you’re paying less in interest than you would with a different type of loan.
At the end of the day, today’s insanely low mortgage rates still make any type of loan a really good option for buyers, but the Conventional loan is by far the easiest to execute and are always preferred by sellers. This might give you a bit of a negotiating edge, but it’s not a golden ticket in our still unstable real estate market. Choose the Conventional loan because it fits your lifestyle and will allow you to purchase the home you need.