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What is a Conventional Loan?
There are many different types of home loans for buyers to consider, which can sometimes feel overwhelming. However, they generally fit into two main categories: those backed by the government and those that aren't. The majority of home loans fall into the latter category, commonly referred to as Conventional loans. These loans come with their own set of guidelines, often set by entities like Fannie Mae and Freddie Mac.
Fannie Mae and Freddie Mac are publicly traded corporations established by Congress in 1938 under the New Deal. Initially designed to boost the mortgage market, they were tasked with increasing the funds available to lenders. While they shifted to private ownership in 1970, they still operate within the framework of a Congressional charter.
In the process of obtaining a mortgage, lenders extend loans to borrowers. Fannie Mae and Freddie Mac then step in to purchase these loans from lenders, ensuring repayment. This setup not only provides reassurance to lenders but also helps maintain liquidity in the mortgage market, allowing for smoother operations and continued lending.
Unlike government-backed loans, Conventional loans operate under different guidelines. They typically offer borrowers more flexibility due to fewer restrictions. This flexibility empowers lenders to tailor terms, features, and benefits to better suit the needs of individual borrowers.
Benefits of a Conventional Loan
Down payment as low as 3%
Fewer restrictions compared with government-backed loans
No upfront mortgage insurance required
Private Mortgage Insurance (PMI) can be canceled after 20% equity is achieved
A borrower must initiate mortgage insurance termination based on original value of property if that property is their principal residence or second home, and the borrower has an acceptable payment record
Higher credit scores can result in a lower interest rate
Less strict appraisal and property requirements than FHA, VA, or USDA loans
Loan processing can be faster
Term lengths can vary between 10 and 30 years
How Conventional Loans Work
There are two main categories of Conventional loans and each one works a little differently.
Conforming loans: Most Conventional loans fall under the category of conforming loans. These loans are standardized and conform to the rules set by Fannie Mae or Freddie Mac. They have maximum loan limits that they must adhere to. In 2024, the loan limit for a single-unit property is $766,550. This limit can be as much as $1,149,825 in high-cost regions. These loan limits are set by the Federal Housing Finance Agency and change each year based on nationwide home prices.
Non-conforming loans: These loans exceed the loan limit set by the government. These Conventional loans do not meet the loan requirements for Fannie Mae and Freddie Mac and they are not bought by them. Instead, non-conforming loans are funded by private lenders. Since they are less standardized, the features of the loan agreement can change greatly from lender to lender.
Conventional Mortgage Requirements
Regardless of whether or not a Conventional loan is conforming or non-conforming, there are some general requirements.
You will need to complete a mortgage loan application and, along with paying applicable fees, have a credit report run. The credit report will examine your credit history and provide a credit score. You must also provide supporting documentation.
These are some of the general requirements needed to qualify for a Conventional loan.
Proof of income such as pay stubs, two years of federal tax returns, two years of W-2 statements, etc.
Asset accounting of bank statements and investments to establish that you can pay the down payment and closing costs.
Employment verification demonstrating you have a stable work history to encourage lenders to work with you.
Miscellaneous documents including your driver’s license or state identification card and your Social Security number.
Minimum credit score of 620
The ability to put down a 3% to 20% down payment depending on your individual credit and income circumstances.
A debt-to-income ratio of no more than 43%. Some lenders will accept a higher DTI with certain conditions.
A borrower may have greater difficulty qualifying for a Conventional loan if their credit score is well under 620, if their DTI is more than 43%, or if they have much less than 20% to put down on a home. They may also have trouble qualifying if they have declared bankruptcy or been foreclosed upon in the last seven years.
Types of Conventional Loans
Conforming Conventional Loans:
Conforming Conventional loans meet guidelines established by Fannie Mae and Freddie Mac. These guidelines include the maximum loan amount, borrower income and credit requirements, and the down payment amount.
Jumbo Loans:
Conventional loans that exceed the loan limit placed by Fannie Mae and Freddie Mac are known as Jumbo loans. These are non-conforming conventional loans. They cannot be sold to Fannie Mae and Freddie Mac. These loans are usually used for more expensive properties than those that fall below the Conforming loan limit. Jumbo loans typically have higher interest rates than conforming loans. They are more difficult to qualify for and are given out less frequently.
Portfolio Loans:
Portfolio loans are also a type of non-conforming loan. They are not sold to Fannie Mae and Freddie Mac, but are instead, kept by the lender on their books. This allows lenders more freedom to set their own terms and qualifications for their loans.
Adjustable-rate Loans (ARMs):
ARMs are mortgages that usually begin with a different (and sometimes lower) interest rate than they finish with. They have an introductory period, similar to how credit cards sometimes offer 0% APR for a limited amount of time. After that introductory period is over, the interest rate will adjust based on the current market rates. The length of the introductory period and the amount the rate increase will depend on the terms and conditions of your individual loan.
Amortized Conventional Loans:
An Amortized loan is a loan that is designed as a series of fixed payments. This means that the loan will have the same monthly payment from start to finish.
Conventional Loans and Private Mortgage Insurance
It is often assumed that Conventional loans require a 20% down payment. Many lenders will actually accept a down payment amount as low as 3%. However, paying a 20% down payment will eliminate the need for the borrower to have Private Mortgage Insurance (PMI).
Private Mortgage Insurance is a type of insurance that the borrower pays in order to secure a mortgage if they don’t have a high enough down payment. Since Conventional loans are not backed by the government, they are considered riskier to lenders. PMI is paid to mortgage insurance companies to give the lender some protection in case the borrower defaults on their loan.
If a borrower makes a down payment of less than 20%, they will have to pay PMI. However, they can cancel the PMI once the mortgage balance is paid down to 80% of the home’s original value. When the balance falls below 78%, the mortgage servicer is required to eliminate PMI, if the borrower meets investor requirements.
If a borrower’s payments are current and the loan is eligible for automatic termination based on its scheduled amortization, then the servicer must cancel MI immediately.
Conventional Loans vs Other Loan Types
FHA loans: FHA loans are the second most popular home loans behind Conventional loans. They are governed by the Federal Housing Administration and backed by the government. An
FHA loan allows for lower credit scores and can be easier to qualify for than a Conventional loan. However, Conventional loans may not require mortgage insurance with a large enough down payment. FHA loans require a larger down payment but allow for a higher debt-to-income ratio.
VA loans: VA loans are designed to help active-duty military and veterans
become homeowners. They are governed by the Department of Veteran Affairs and guaranteed by the government. Since they are backed by the government, they generally offer lower interest rates and better terms than Conventional mortgages. They are offered exclusively to servicemembers and certain military spouses and have very specific requirements.
USDA loans: USDA loans are designed for borrowers who would like to buy property in certain rural areas. They are governed by the Department of Agriculture and are also backed by the government. USDA loans have specific eligibility requirements including location and income levels. They have lower interest rates than Conventional loans and do not require a down payment. They do not have maximum or minimum loan limits and they have more flexible credit score requirements than Conventional loans. The USDA also offers 100% financing for qualified borrowers.
FAQ's
Why Should I Pursue a Conventional Loan Over a Government Loan?
Conventional loans make up most home loans. Conventional loans and government loans have different backing and requirements. Which one is right for you will depend on your individual needs. For instance, while Conventional loans have fewer restrictions overall, a military member might be better off using a VA loan. This is because VA loans are specifically designed to benefit homebuyers with military affiliations.
Conventional loans do, in general, have fewer restrictions on them than government loans. This allows lenders to be more flexible with the terms and conditions of their loans. So, if a borrower meets the requirements for a Conventional loan, it may serve them better than certain government loans would. It all depends on the individual borrower’s circumstances and needs.
Who Qualifies for a Conventional Loan?
A Conventional loan has the following minimum requirements:
Proof of income, assets, and funds for a down payment.
A 620 minimum FICO score.
A borrower can increase their chances of qualifying for a conventional loan by improving their credit score, having a debt to income ratio under 43%, and saving enough for a 20% or more down payment on their new home.
How Much Do I Have to Put Down for a Conventional Loan Mortgage?
Conventional loan mortgages do not require a 20% down payment, although doing so eliminates the need for Private Mortgage Insurance (PMI). Conventional mortgages typically require a minimum 3% down payment, but that number can be higher depending on a borrower’s credit score, loan-to-value ratio, credit history, and debt-to-income ratio.
How soon can I Refinance an FHA Loan to a Conventional?
You can refinance an FHA loan to a Conventional loan when you reach 20% equity on your home.
Refinancing your FHA loan to a Conventional loan can have a lot of benefits. In some cases, refinancing to a Conventional loan can lower your monthly mortgage payments by lowering your interest rate. It can also eliminate the mortgage insurance required for all FHA loans.
It should be noted that FHA loans and conventional loans do not have the same credit standards, so depending on your situation, you may not be able to qualify for a conventional loan.
When deciding if refinancing is right for you, make sure to consider what home prices and mortgage rates may do in the future. You should also evaluate all costs and benefits, as refinancing into a new loan will carry some closing costs that will need to be paid, either up front or rolled into the loan.
Can I get Down Payment Assistance with a Conventional Loan?
Yes, down payment assistance is available for Conventional loans. However, there are many factors that go into qualifying for down payment assistance.
E Mortgage Capital, Inc. is a full-service mortgage company that offers extensive options for residential mortgages, with quick service and leading rates.
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