Conventional vs Unconventional Loans

When talking about loans, the first step you can take is to learn about two basic classifications of home loans: conventional and unconventional. Each loan type has its advantages and disadvantages for the borrower. Let’s take a look at conventional loans first.

What Are Conventional Loans?

Conventional loans are not secured by an established government program like the Federal Housing Administration (FHA), Department of Agriculture (USDA) or Department of Veterans' Affairs (VA). Instead, they're offered by private lenders and will generally follow more strict requirements compared to other loan types.

Conventional loans are also known as conforming loans because they "conform" to the rules set forth by Fannie Mae and Freddie Mac, the two largest investors of conventional loans. They're ideal for borrowers who already have excellent credit. If the borrower is in good economic standing and can provide a large down payment, the process shouldn't be hard for them. And there are added benefits too, such as flexibility in terms of the property that you can purchase and the chance to significantly reduce your mortgage insurance.

There are two basic types of conventional loans: fixed-rate mortgages and adjustable rate mortgages.

Fixed rate mortgages have an interest rate that never changes. The monthly payment for your loan will always be the same.

An adjustable-rate mortgage (ARM) has an interest rate that varies throughout the life of the loan. After an initial "fixed-rate" period, the interest rate can adjust up or down, depending on the market. These adjustments happen periodically, often yearly or even monthly.

What are Unconventional Loans?

As stated before, conventional loans require a higher credit score, lower debt-to-income ratio and larger cash down payment. Sometimes, this won't fit a borrower's needs. That is where an unconventional loan comes into play.

In reference to its name, unconventional loans are different from most loans. They're backed by the government or secured through a bank or private lender, making them ideal for individuals with a lower income or less than perfect credit. The only real downside is that the loan limit is lower.

When we talk about unconventional loans, we often hear about FHA loans and VA loans.

FHA loans are insured by the Federal Housing Administration and require a small down payment.

VA loans are backed by the Department of Veterans Affairs. They generally do not require a down payment, but veterans and active duty personnel who secure a VA loan do need to certify that they intend to personally occupy the property as a primary residence.