Conventional Loans
What is a Conventional Loan?
You have probably heard of a Fannie Mae or Freddie Mac loan. That is a conventional mortgage loan. These are the most common mortgages in the USA. These loans are not associated with any special eligibility requirements, and just about all mortgage lenders provide them. You can qualify for one of these loans with a 620 FICO credit score or higher.
What Are the Requirements for Conventional Loans
The loan requirements for conventional loans typically vary from one lender to the next, but every conventional loan is required to match up to specific guidelines that have been set by Fannie Mae and Freddie Mac: A debt-to-income ratio (DTI) that is lower than 43% but can go as high as 50% on certain loan scenarios. A credit score of 620 or higher. Down payment as low as 3% for some scenarios.
The amount for a conventional loan must be within the conforming loan limit, which is currently $726,200 in most areas but can be higher in a few high-cost areas around the country. Higher credit scores and higher down payments generally receive the best interest rates.
What is the Minimum Down Payment for a Conventional Loan?
It is possible to get a loan with a small down payment of just 3%. There are 6 main mortgage options when it comes to the down payment requirement for conventional mortgage loans. Some of these conventional loan types include: Conventional Loan without PMI: 20% Down Payment. Conventional Loan with PMI: 5% Down Payment. Freddie Mac Home Possible Loan: 3% Down Payment. Conventional 97 Loan: 3% Down Payment. Fannie Mae HomeReady Loan: 3% Down Payment.
Why 20% Down?
If your down payment is less than 20% on your conventional loan, lenders require that you have PMI (Private Mortgage Insurance). This is coverage that helps to protect lenders when the borrower defaults on his/her loan. PMI can increase your mortgage payments and depends on credit FICO score along with several other factors like DTI. With higher credit scores, lower down payments can offer the PMI option but with minimal effect on total mortgage payment. This allows borrowers to put less money down and still get a payment that works for them. PMI can be more prohibitive with lower credit scores and open up looking at alternative loan options like an FHA loan to minimize the effect of the PMI and lower down payment.
Typically, you can cancel your conventional PMI if it is part of your mortgage payment once your mortgage loan balance reaches 80% of what you paid for the home or current home value. This means that you won’t be stuck with PMI forever. On primary residences the PMI will cancel automatically once the loan balance reaches 78% of what you paid for the home.
What are Conventional Loan Rates Like?
Conventional loans are associated with lower rates that often makes the process of buying a home a lot more affordable.
The rates for conventional loans are based heavily on the credit score of the applicant (even more so than the rates for FHA loans). For example, if the home buyer has a 20% down payment and a credit score of 740, they will typically secure a 0.50% lower rate when compared to buyers with scores of 640. These rates are also worked on MBS (mortgage-backed securities) that are traded in a similar way to stocks. And just like stocks, the rates for conventional loans change consistently throughout each day, sometimes 3-4 times per day. That is why it is important to check-in with us about current rates for your scenario.
One of the best approaches to make sure you secure the lowest rates is to keep an eye on market movements, which will allow you to monitor the rates. The rates for conventional loans can rise or drop very quickly when any financial news is released to the market. For example, if the Federal Reserve has decided to cut the benchmark rate, this would cause the rates for conventional loans to fall typically.
It is very important to obtain a personalized rate quote from us. The rate averages that are published online and in the media are mainly based on “perfect” applicants, which are people with large down payments and great credit scores. Your personalized rate quote may be lower or higher.
The Advantages of Conventional Loans
Conventional loans are the most common and popular mortgage type. After this comes the government-backed mortgages, which includes VA, and FHA loans. The government-backed mortgages offer a few unique benefits such as credit guidelines that are more flexible and smaller down payments. First-time homebuyers with lower credit scores and the need for a lower down payment will typically choose and FHA mortgage.
Conventional mortgage loans offer various types of repayment plans, and the borrower does not have to match up to “special” criteria such as geographic location or military status to qualify. There is also no upfront fee required for mortgage insurance.
Flexible Repayment Plans
Like other types of mortgages, conventional loan products provide multiple repayment options. Conventional mortgage loans are available in 10,15, 20, 25, and 30-year terms. The monthly payment on loans is higher with the shorter loan terms. Luckily, the fixed-rate 30-year conventional loan is linked to fixed-interest low payments that are still accessible to most home refinancers and buyers. Typically, on a 30-year mortgage, 75% of your mortgage payment will go to interest and the rest to principal. On a 20-year mortgage it will be more like 50% of your payment is going to interest, while on a 15-year mortgage 25% of your payment will go towards interest. Borrowers that can afford a 15-year payment can pay a lot less interest over time, pay the loan off faster, and usually pay a lower interest rate than the longer terms.
Adjustable-Rate Options (ARM)
A conventional loan is a better option for people that know they don’t plan to stay in a house for very long and who want an adjustable-rate, shorter-term mortgage. This is an option that features an interest rate that is usually lower than fixed-rate loans. The adjustable-rate loan is also fixed, but only for a few years, which is usually 3, 5, 7, or 10 years. During that fixed period, the owner of the home will usually pay a lower interest rate which can help the borrower to save thousands in interest during that time. Today, many buyers of homes often select a 5-year ARM or a 7-year ARM. This type of loan can result in significant savings while allowing the buyer of the home ample time to either sell the property, refinance to one of the fixed-rate loans, or even pay their mortgage off entirely. However, once the fixed period expires, the interest rate on the loan and the monthly payments made towards the mortgage may increase or decrease each year, which will depend on current market conditions.
No Special Requirements Needed to Qualify
Unlike a government-backed mortgage, a conventional loan is not attached to any special requirements. They are made available to any applicant that has a stable income, an adequate credit score, and enough money for the down payment. The loans that are government-subsidized have a specific purpose and are usually linked to several limitations.
VA loans are only available to former and current members of the military. These loans provide many benefits including no mortgage insurance and zero down payment. Yet this loan type is not available for the rest of the population.
FHA loans are often regarded as a powerful home-buying tool. However, they are associated with mortgage insurance costs that are typically higher and payable over the life of the loan. Again, this loan type if great for first-time homebuyers with lower credits scores and in need of a lower down payment option.
With a conventional loan you may purchase a second home or investment property. Government-backed loan programs cannot be used to buy a second home or for investment properties. They are more focused on helping Americans to purchase homes that they use as their primary residence.
No Upfront Mortgage Insurance Fee
Conventional loans won’t require a mortgage insurance fee upfront, even when your down payment is less than 20%.
FHA loans and VA loans require the insurance fee upfront, which is typically between 1% and 4% of the total loan amount. Conventional mortgage loans will only require mortgage insurance premiums that are paid monthly if the borrower has put down under 20%. Mortgage insurance on a conventional loan might be lower when compared to a government loan if your down payment is higher and you have a high FICO credit score.
The Pros and Cons of Conventional Loans
Qualifying for a Conventional Loan
Many potential home buyers are under the impression that it is difficult to qualify for conventional mortgages, especially when their financial affairs are less than perfect. But that is not really the case normally.
Like a government-backed loan, the process of qualifying for a conventional mortgage loan means that you have to show: You are earning enough to cover your monthly payments. The income that you earn is guaranteed or “expected” to continue. You have enough money to cover your down payment. You have a good credit score, and your credit history is good. The standards that apply to successfully qualify for conventional loans may be slightly higher when compared to VA or FHA loans, but they are also more flexible which enables most buyers of homes to qualify.
Credit Score Needed for a Conventional Mortgage
Typically, a higher FICO credit score is required on a conventional loan. It really depends on a lot of factors like credit history in addition to down payment and debt-to-income ratio (DTI). Mortgage insurance can also be very expensive for lower credit scores and lower down payments which can make a conventional loan less attractive. A lower credit score with a higher down payment and no mortgage insurance will usually work for a conventional mortgage although the interest rate will be higher than it would be for a higher FICO credit score because of the risk of the lower FICO credit score.
The applicants that have a lower credit score may be better off choosing an FHA loan, that does not charge higher rates or extra fees for credit scores that are lower. Make sure you have checked on your most recent credit report well before you start applying for mortgages so that you are aware of where you currently stand.
Income and Employment
During the application process for a mortgage, the homebuyer is required to provide proof of what they earn, which can involve a few or all this type of documentation: Last 2 years of W2s. Last month of paystubs. An offer letter for a job that hasn’t started yet but will start within the next 60 days. Copy of school transcripts for new graduates.
Property Value
Mortgage lenders will not approve mortgages for amounts that exceed what the home is worth. Before they close on any loan, lenders will have the property appraised to determine the true value. The appraisal will be ordered by the lender.
For example, if a buyer has offered to pay $200,000 for a property, but once appraised the property is valued at $190,000. In this scenario, the buyer can use the appraisal to ask the seller if they will lower their price to what the lender is willing to finance. Or the buyer could choose to pay the extra $10,000 from their own funds to balance the lowered borrowing limit. This $10,000 would then be added to a down payment that the buyer has already agreed on paying.
Value is just one of the things to take into consideration when obtaining an appraisal for a conventional mortgage loan. In some cases, during the inspection, an appraiser may request the opinion of another professional. For example, if an appraiser notices leaky faucets and water stains on the ceilings or wall, they may ask for a professional plumbing inspection. This may result in the seller having to make some improvements to the property, which may delay the closing. However, most conventional loan products are associated with property requirements and appraisals that are less strict when compared to VA, or FHA loans. This is one of the other advantages of conventional loans, buyers may qualify for homes that are in less-than-perfect condition and make necessary repairs later once they have moved in.
Down Payment needed for a Conventional Loan
The down payment from the borrower often affects not only their interest rate but also the final costs of the loan. The larger the down payment, the lower the monthly payment. A down payments of 20% or more will do away with mortgage insurance. In comparison FHA loans will require that the borrower has mortgage insurance even when they have a down payment of 20% or more.
Conventional Loan Down Payment Information
| Loan Type | Requirements |
|---|---|
|
5% Down payment with PMI (mortgage insurance) – Conventional 95 |
Must be a primary residence. |
|
3% Down payment with PMI (mortgage insurance) – Conventional 97 |
Must be a primary residence. No income limits. At least one borrower must be a first-time home buyer. May require home buyer education. |
|
3% Down payment with PMI (mortgage insurance) – Fannie Mae HomeReady or Freddie Mac Home Possible |
Must be a primary residence. Has income requirements. Must be below or at the median income for a geographical area unless the property is situated in an under-served area. May require home buyer education. |
|
10% Down payment with PMI (mortgage insurance) – Conventional 90 |
Can be primary residence or second home, although second home interest rates are substantially higher. |
Are There Drawbacks to the 3% Down Loans?
Interest rates can be higher on a 3% down loan. The mortgage insurance can also cost more when compared to the 10% or 5% down conventional mortgage loans.
Your Down Payment
Conventional loan borrowers have the choice to put anything from 3% to 20% down or more. A down payment gift may cover the whole amount in certain cases. Check with us for donor and gift documentation requirements. Unless it is a gift, applicants are required to verify a source that is valid where the down payment will be coming from such as their checking or savings account. It is good to speak with us about this documentation early in the process to make the paperwork part of your application seamless.
Applicants also have the option to liquidate an investment account or use funds from a retirement account to cover their down payment. Normally the last 2 consecutive statements for these accounts are required for underwriting.
PMI (Private Mortgage Insurance)
PMI or private mortgage insurance is a requirement for all conventional loans with a down payment that is less than 20%. PMI rates can vary significantly based on the down payment and the applicant’s credit score. Higher mortgage insurance premiums for borrowers that have lower credit scores often prompt these borrowers to go with an FHA loan. Unlike the conventional loan, an FHA loan does not charge a higher insurance rate, even when the applicant has a very low score.
Loan Limits on Conventional Loans
The nationwide loan limit on conventional loans starts at $726,200 for 2023 and changes yearly. Typically, it increases yearly. Some locations around the country are considered higher cost areas and therefore have a higher loan limit. The loan limit is also set for 2-, 3- and 4-unit properties as well.
Debt-to-Income Ratio (DTI)
DTI compares the monthly debts of the applicant (total), which includes mortgage costs, to the applicant’s monthly gross income. This figure is then used to work out what type of mortgage payment is going to match the applicant’s monthly budget. Most lenders want the ratio to either be equal to or lower than 36% of the gross monthly income of the borrower. However, some of the conventional loan products can allow a DTI of up to 50%.
Conventional Loan Closing Costs
The closing costs on a conventional loan can include an origination fee or discount points from the lender, along with vendor fees including title insurance, credit reporting fees, and the appraisal. There are also local and state fees and taxes that are paid along with escrow items like property taxes and homeowner’s insurance. The seller, lender, or real estate agent can pay some or all of these expenses. These parties can contribute towards certain maximum amounts, which is usually based upon the amount of the down payment and the price of the home. A down payment of less than 10% has a maximum amount that can be paid of 3% of the purchase price of the home. Between 10% and 25% down payment, 6% max of the purchase price. Over 25% down payments allow up to 9% of the purchase price. With investment or rental properties, the seller, lender, or real estate agent is only allowed to contribute 2% of the purchase price to pay towards the borrowers closing costs.
Apply for a Conventional Loan
Complete your pre-qualification online today. Click the link below and we’ll walk you through the steps to begin the home financing process.
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