Conventional Loans

Conventional loans are based on guidelines set by private investors and are not guaranteed or insured by an agency of the federal or state government. These loans may be purchased and securitized by Government Sponsored Entities ("GSE") such as Fannie Mae and Freddie Mac or by other institutions participating in the secondary market. However, loans that are insured by VA or FHA are not conventional loans. Another way to think about conventional loans is that these are non-government loans.

A lender has the freedom to customize the features, pricing, and underwriting requirements of conventional loans. The greater the customization the less marketable the loan becomes in the secondary market. Since most lenders intend to sell loans in the secondary market, they don’t customize the loans and follow the underwriting guidelines of Fannie Mae, Freddie Mac, or of an investor whose loans are easily traded in the secondary market.

Benefits of Conventional Loans

1. Wide Selection of Loans: Conventional loans include a wide selection of products to meet the individual needs of the borrower. They range from Prime paper loans to subprime mortgages. From fully amortized to negative amortizing loans.
2. Customized to Needs: The loan product may be customized to the individual needs of the borrower. The customization is especially true with commercial mortgages and construction loans. Some unique situations could be:
   1. High LTV Loans, even greater than 100% LTV (to cover move-in costs, furniture, etc.)
   2. Loan against combination of personal and real property
   3. Financing origination and other fees within the loan
   4. Non-Arm’s length transaction
3. Flexible Underwriting: Since the loan does not need to follow any agency guidelines, the lender may define its own underwriting and documentation requirements. For example, the lender may require collateral in addition to the subject property or ask for personal guarantees.

Disadvantages of Conventional Loans

1. Higher Costs: Conventional loans are usually more expensive for the borrower than government loans. The higher costs reflect in higher fees, higher interest rates, or a combination of both. This is because of following reasons:
   1. Lack of Government Insurance: The lack of government insurance increases the risk for the lender. As a result, the lender charges higher fees to cover for the higher default risk.
   2. Limited Liquidity: Conventional loans are less liquid than government loans. This increases the risk for the lender and therefore the carrying costs. This is especially true for loans that may be customized for the borrower.
   3. No Fee Limits: There are no limits to the fees a lender may charge. However, the lender would still need to comply with the usury laws, and other regulations.

Updated: Jul 25, 2013