Conventional loan

Key Takeaways

• A conventional loan is any mortgage that no government program insures or guarantees. The lender carries the credit risk and writes its own qualifying rules.
• Seller financing is conventional financing, because no government agency stands behind the seller's note.
• Underwriters read a conforming conventional file through two ratios, the housing expense ratio and the total debt ratio.
• In Washington a conventional home loan is normally secured by a deed of trust under chapter 61.24 RCW. That lets the lender foreclose by trustee's sale instead of going to court.

What It Means

A conventional loan is a mortgage that no government agency insures or guarantees. The label describes who stands behind the debt, not the size of the loan or the kind of property. If it is not an FHA insured loan, a Va Loan, or a USDA loan, it is conventional, and conventional mortgages are the first of the three families of mortgages a course covers.

Because no agency will reimburse the lender after a default, the lender writes its own rules. It sets the credit score it wants to see, the Down Payment it expects, and the mortgage insurance it will require. Underwriters then read the file through two ratios, the housing expense ratio and the total Debt To Income Ratio. The question is not how much a borrower earns, it is how much of that income is already promised to other debt.

Seller financing counts as conventional financing, which catches students by surprise: a seller who carries the paper has made a conventional loan, because no government program guarantees it. Conventional is also not the same word as conforming. A conventional loan that fits Fannie Mae and Freddie Mac limits is called conforming, and one too large for those limits is still conventional. For the wider map, see our guide to the loan types every broker should know.

How It Works in Washington

Washington is a deed of trust state, so a conventional home loan here is secured by a Deed Of Trust rather than a true mortgage. RCW 61.24.020 provides that "a deed of trust is subject to all laws relating to mortgages on real property" and that the security instrument "may be foreclosed by trustee's sale," which is the nonjudicial route that keeps most Washington foreclosures out of court.

That choice carries a consequence every conventional borrower should understand. RCW 61.24.100(1) bars a deficiency judgment "against any borrower, grantor, or guarantor after a trustee's sale under that deed of trust," except as the section allows for commercial loans. RCW 61.24.005(6) defines a commercial loan as one "not made primarily for personal, family, or household purposes." A conventional loan on an owner's home sits outside that exception. If the trustee sells the house for less than the balance, the lender generally cannot pursue the borrower for the shortfall.

The origination side is regulated too. Under RCW 19.146.200(1) a person may not engage in the business of a mortgage broker or loan originator without first obtaining and maintaining a license, unless RCW 19.146.020 exempts them, so the person who takes a conventional loan application in Washington is licensed and traceable.

Example

Priya and Marcus Hale buy a townhouse in Renton for $585,000. They put $58,500 down, which is 10 percent of the price, and finance $526,500 with a 30 year fixed conventional loan at 6.75 percent. No agency insures the loan, so Cascade Mutual Bank sets the terms itself. It requires private mortgage insurance because the Hales financed 90 percent of the price. Under 12 U.S.C. 4901 and 4902 they may ask to cancel that coverage when the balance reaches 80 percent of the original value, and the servicer must terminate it at 78 percent if the payments are current.

Principal and interest come to about $3,415 a month. Add $520 in property taxes, $95 in hazard insurance, and $180 in mortgage insurance, and the housing payment is $4,210. Against a gross monthly income of $13,000, that is a housing expense ratio of about 32 percent. A $480 car payment and $310 in student loans push the total debt ratio to about 39 percent, and the underwriter approves the file. At closing the Hales sign a promissory note and a deed of trust that is recorded in King County, which is what gives Cascade Mutual the trustee's sale remedy in chapter 61.24 RCW. Rates move all of these numbers, so it is worth reading how interest rates shape Washington home sales.

Common Mistakes and Exam Traps

• Conventional and conforming are not the same word. Conforming means the loan meets Fannie Mae or Freddie Mac limits and guidelines, and a conventional loan that exceeds them is still conventional.
• Seller financing is conventional financing. The test is whether a government program insures or guarantees the loan, not whether a bank made it.
• The security instrument does not tell you which loan is which. In Washington a conventional loan and an FHA loan are both normally secured by a deed of trust.
• A completed trustee's sale usually ends the borrower's liability. RCW 61.24.100(1) bars a deficiency judgment after a trustee's sale except as that section allows for commercial loans.