Conventional vs. Government Loans

Technically there are two types of loans: conventional and government loans

. Conventional loans encompass loans underwritten by banks and other lending institutions which follow Fannie Mae and Freddie Mac guidelines. Government loans are the loans that are underwritten in such a way that they follow Ginnie Mae guidelines. FHA, VA and USDA loans belong to the latter category.

Conventional loans can be further divided into conforming and non-conforming loans. Conforming loans are those loans that do not exceed certain loan limit. This limit is computed annually by the Office of Housing and Urban Development by calculating the average home price in the country. This price is then compared to the average price from the previous year. If the prices increase by certain percentage, the new limit is established by increasing the allowable loan amount by that percentage.

If the last year loan limit, for example, was $300,000 and the average price increase last year was 10% then the newly calculated maximum limit for the loan would be $330,000. It is also worth noting that what was once called non-conforming loan or jumbo loan is now carrying the name of super-conforming loan.

Non-conforming loan, on the other hand, is the loan that exceeds the calculated limit. If the loan amount is thus greater than $417,000, which is the limit as of this writing, any loan above that amount would be considered a non-conforming loan, better known as a jumbo loan.

The main difference between conventional mortgage and government one depends on who guarantees the loan. Conventional mortgages are guaranteed by the private lender. It means that if for whatever reason the borrower defaults on his or her mortgages the lender, and only the lender, loses and often has to write off bad loan.

Here is an example. The bank sells the loan that was underwritten under the conventional guidelines to the other bank, on the secondary market, and after some times the borrower defaults on the mortgage. The bank that bought the loan can do nothing but take the hit. However, if it turns out that the selling bank bypassed' some of the guidelines, either by accident or on purpose, or that the borrower gave fraudulent information while applying for the mortgage, the original banker has to purchase that loan back. Examples might include: giving misleading and untrue information about the income, source of money used for down-payment or the real expenses.

If the borrower defaults on the loan that was underwritten according to FHA, VA or USDA guidelines, then the government insures the lender and it covers banker's loses. Again, if the guidelines were not met and there was a mistake, misrepresentation or fraud involved, the original lender would have to buy the loan back. If the underwriting criteria were met and the borrowers still defaulted on their mortgages, the bank that originally sold the loan on the secondary market would not be responsible for the borrowers' default. Instead, the property would go into VA or FHA foreclosure (HUD foreclosure) and that is how the government would get its money back.

Conventional vs. Government Loans

By: Mark Badowski

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