A conventional loan is a mortgage obtained from a private lender without government backing and with a down payment large enough to satisfy the lender's standards. With a large enough down payment, the borrower does not need to pay private mortgage insurance. If a borrower does not meet lenders' criteria for loan approval, or if she does not have enough of a down payment, she won't be able to get a conventional loan and may have to pay for mortgage insurance.
Conventional vs. FHA
In home finance terms, a conventional loan is simply a mortgage obtained without help from the Federal Housing Administration, or FHA. Typically, for a conventional loan, prospective homebuyers go to a lender and apply for a mortgage; the lender reviews the applicants' credit history and current finances and, if they meet the lender's standards, approves a loan. Some people don't meet lenders' standards. In that case, the homebuyers can apply for a loan guarantee from the FHA. An FHA guarantee assures a lender that the government will pay the mortgage if the borrower defaults on it.
Lenders want to see homebuyers putting their own money on the line. The more of their own money they have invested in a house, the more likely homeowners are to faithfully make their payments. That's why lenders usually require borrowers to make a down payment; the standard amount is 20 percent of the value of the home. Borrowers can still get a loan with a down payment of less than 20 percent, but the lender is going to make them pay for mortgage insurance -- an insurance policy that pays the lender if the borrower defaults on the mortgage.
Borrowers with FHA-backed loans purchase their mortgage insurance directly from FHA. Borrowers with conventional loans must purchase private mortgage insurance, or PMI, from a company selected by their lender. The borrowers pay for the insurance with premiums added to their monthly mortgage bills. A conventional loan without PMI, then, is one where the lender was satisfied with the borrower's down payment and didn't require private mortgage insurance.
The advantage of having a loan without PMI is obvious: You don't have to pay for mortgage insurance, saving you a little bit of money every month. And conventional loans have distinct advantages over FHA loans. For one, interest rates on conventional loans are typically lower than those on FHA loans, reflecting, among other things, the lower perceived risk of conventional loans and the higher administrative costs involved with getting FHA approval. Also, conventional loans are essentially unlimited: As long as borrowers can afford the payments, they can buy as expensive a house as they want. The maximum size of an FHA loan, however, is limited by law. As of 2011, the biggest FHA loan you could get for a single-family home in most areas of the country was $271,050; it was higher in high-cost areas.
- Bankrate; FHA vs. Conventional Mortgage; Don Taylor; May 2005
- The Mortgage Professor; FHA Mortgages - A 2009 Update; Jack Guttentag; September 2009
- Bankrate; Conventional, VA, FHA Mortgage; Steve Santiago; September 2008
- "The Washington Post"; FHA Loans Emerge from the Sidelines; Dina ElBoghdady; June 2008
- U.S. Department of Housing and Urban Development: FHA Mortgage Limits