Conventional loans are loans made by private parties and non-government lending institutions without any government insurance or government guarantee against loss for the lender. Conventional loans that conform to the eligibility guidelines for purchase by Fannie Mae or Freddie Mac are considered conforming loans. Fannie Mae and Freddie Mac have maximum loan limits for loans they will purchase, which is adjusted annually.
Conventional loans can be insured or uninsured. Generally, a conventional loan of up to 80% of the property’s value will be made without private mortgage insurance. To compensate for the greater risk when the loan is above 80% of the value, some lenders will charge higher interest rates. However, most require that the loan be insured by a private mortgage insurance company.
Private mortgage insurance (PMI) is an insurance policy issued to provide protection to the mortgage lender in the event of financial loss due to a borrower’s default. In the event of a default, the insurance company will either pay off the loan or let the lender foreclose and pay the lender for much of its losses.
The borrower pays a mortgage insurance premium, either at closing, as a lump sum covering the life of the loan, or by paying the first year’s premium at closing and then paying annual premiums as part of his mortgage payment. The amount of the premium is a percentage of the loan amount based on the borrower’s down payment. The annual premiums and the insurance stop once the loan is paid down to 78% or 80% of the value of the property at the time the loan was taken.