Conventional home loan in Colorado Springs: What is it?
When a prospective buyer decides to take out a loan to purchase a home, they have two options. One is to take out a mortgage loan that’s backed and insured by the federal government, through an agency like the Federal Housing Administration (FHA) or the Veterans Administration (VA).
The other, more commonly used option is a conventional home loan, which is backed by a private lender — a bank, credit union, or other financial institution — rather than a government agency. In a conventional loan arrangement, the borrower usually pays the loan insurance premium themselves.
Private lenders assume the risk in a conventional mortgage loan. If the borrower defaults on repaying the loan, the lender attempts to recover the amount they’ve advanced, typically by foreclosing on the home or short selling the property.
How does a conventional loan work?
A conventional mortgage loan in Colorado Springs is a little like any other credit account or debt repayment arrangement — but with more moving parts, more minimum requirements, and, of course, more money.
Conventional mortgage lenders seek to ensure that the borrowers they work with are good risks with solid credit histories, and who can afford to make monthly repayments on their loan. Lenders also qualify borrowers by their ability to handle all of the associated fees with a home purchase, including brokerage fees, underwriting, and closing costs, among others.
When applying for a conventional loan, the homebuyer submits documentation that outlines their current financial status. Typical documents include proof of income (pay stubs, W-2’s, tax returns, and so forth), verification of employment, bank and investment account statements, and identification. Lenders will also check up on the borrower’s credit history and score.
After a borrower is approved for a conventional home loan, makes a down payment and forwards all the administrative costs, the lender funds the loan and the transaction enters the closing process.
How a conventional home loan benefits the borrower
Conventional home loans have a few distinct advantages toward federal-issued mortgage loans:
More flexibility. Conventional home loans typically give buyers more options. They can customize the repayment period, opt for fixed or adjustable interest rates, make arrangements to repay taxes or insurances from a different escrow account, and more.
Faster processing. Private lenders generally require less paperwork than government lenders, reducing the amount of red tape necessary to process the loan. Federal loans may also take longer to take effect due to inspections or property repairs which can delay approval. Conventional loans usually don’t have those requirements, so approval decisions are made more quickly
Security. Most conventional loans have fixed interest rates, meaning they’ll never change even if federal interest rates increase or property values rise. Should federal rates fall, conventional loan borrowers usually can refinance their mortgage — another example of their flexibility.
Possible drawbacks to a conventional home loan
Although a conventional home loan gives the buyer more leverage in flexibility, options, and financing, it carries some potential disadvantages:
Harder to qualify. Since private, commercial lenders are responsible for the issuance of the home loan, they have more stringent requirements for approval. Conventional loan applicants generally need to have higher credit scores and meet stricter income minimums than federal loan seekers.
Higher down payment. Most conventional loans require that the borrowers pay more money upfront toward their home purchase, sometimes as much as 20% of the total sale price
Riskier. Conventional loans are not insured by federal institutions. Since the government doesn’t guarantee that lenders will get repaid if the borrower defaults, the lenders must assume the financial risk themselves with no assurance of federal assistance.
More insurance costs. With no insurance from the federal government, lenders pass that obligation down to the home buyer. This means conventional loan borrowers must pay insurance premiums on top of their mortgage payments and administrative fees.
Who can qualify for a conventional home loan
The requirements for obtaining a conventional home loan vary from lender to lender — some are tougher than others. Generally, however, the baseline qualifications a lender looks for include:
Good credit score. The current minimum credit score for conventional home loan approval is 640. Some lenders may accept scores as low as 620 with heavy conditions attached. The higher the score, of course, the better; one close to 720 is ideal.
Low debt-to-income ratio. Lenders evaluate what percentage of a borrower’s monthly income goes toward the repayment of the debts they’ve incurred. The lower this ratio is, the more confident the lender feels about a customer’s ability to make monthly mortgage payments. A debt-to-income ratio of 36% or less is ideal for a conventional loan, but some lenders may approve loans to borrowers with ratios up to 43%, with certain additional conditions.
Verifiable sources of income. Lenders look at W-2 forms and tax returns to determine that the borrower has a stable income stream from the previous two years. They may make exceptions on a case-by-case basis for recent college graduates or other major life events.
No major credit disruptions. The borrower’s financial history should be free of recent bankruptcies, repossessions, foreclosures, or any other events that harm their credit score.
Ability to make down payment. Lenders want to see that the borrower can easily forward a down payment from a verified and trustworthy asset source.
What kinds of buyers benefit the most from conventional home loans
Conventional home loans reward homebuyers who demonstrate repeated and sustained fiscal responsibility. Those with higher credit scores especially benefit, since their mortgage rates go down — as do their monthly payments — as their credit score goes up.
Buyers who plan to stay in their new home for a long time also benefit the most from conventional loans. Home equity (the difference between one’s mortgage debt and their home’s dollar value) gradually decreases over the life of a mortgage. When it gets to a certain level, usually around 20%, lenders will often eliminate the requirement that borrowers carry loan insurance. Federal loan borrowers don’t have that option. The longer one stays in their home, the more affordable a conventional loan may be.
Differences between conventional and federal loans
Conventional loans are not federally insured. Private lenders assume all the risks of a conventional loan if the borrower defaults or fails to maintain payments. They usually require buyers to take out mortgage insurance. Federal loans are backed by the government — if the homebuyer defaults, federal agencies ensure the lenders get repaid.
Conventional loans have higher requirements. Since they’re riskier, conventional loans require that borrowers’ financial histories meet higher standards. Federal loans are often available to those with lower credit scores, riskier financial states, or other factors that prevent them from getting conventional loans.
FHA loans are available to more buyers. Because of these lower requirements, FHA loans are accessible to a wider cross-section of potential home buyers. Federal agencies also have special mortgage programs for military veterans and buyers in certain rural areas.
FHA loans usually have lower interest rates. The government's backing of federal loans allows them to charge lower interest rates throughout repayment than conventional loans. Federal interest rates tend to be lower, by as much as .25%.
FHA loans usually have lower upfront costs. Down payments on conventional loans can run anywhere from 3% to 20% of the total home value. Federal lenders often require down payments as low as 3.5%.
FHA loans usually have lower insurance premiums, with a catch. If federal lenders require the buyer to take out some form of mortgage insurance, the premiums are usually more reasonable than conventional loans. However, the closer a conventional borrower gets to the end of their payment period, the likelier they won’t have to pay any insurance after a certain point.