Table of Contents
A conventional loan is one that is not formally backed by any government entity such as FHA, VA, and USDA. Rather, it is a loan that follows guidelines set by Fannie Mac and Freddie Mae, two agencies that help standardize mortgage lending in the U.S.
Conventional loans are also known as conforming loans because they “conform” to Fannie Mae and Freddie Mac standards.
What Are Conventional Mortgage Advantages?
An advantage to conventional loans is the lack of an upfront mortgage insurance fee, even if the buyer puts less than 20 percent down. FHA loans, USDA mortgages and even VA loans require an upfront “funding fee” usually between 1% and 3% of the loan amount. This means your ‘closing costs’ (the upfront costs at close of escrow) will be lower with a conventional loan.
Conventional loans only require a monthly mortgage insurance fee, and only when the homeowner puts down less than 20 percent. Plus, that mortgage insurance cost is often lower than that of government-backed loans.
FHA loans are a powerful home buying tool, but can come with high upfront and monthly mortgage insurance fees that are payable for the life of the loan — up to 30 years. The only way to cancel FHA mortgage insurance is to refinance out of the FHA loan. This can incur additional costs.
Conventional loan rates are heavily based on credit score, more so than rates for FHA loans. Fannie Mae and Freddie Mac publish Loan Level Price Adjustments which increase interest rates for lower-credit-score buyers. This is why an FHA loan is often more suitable for these applicants. For instance, a home buyer with a 740 score and 20% down will be offered about 0.50% lower rate than a buyer with a 640 score.
How much downpayment are you required to provide? That depends on the program you qualify for, 5% down is common. There is also a ten-percent-down and a three-percent-down conventional loan. Low-downpayment options not only exist but are extremely popular with today’s buyers. However investors need to put a minimum of 20% down. And as I stated previously a higher downpayment can lower your interest rate
It’s important get a personalized rate quote. Published rate averages are often based on the “perfect” applicant — one with great credit and a large downpayment. Your rate might be higher or lower.
The minimum accepted score for most conventional loans is 620. We want to know that people pay their bills on time and are financially disciplined and good at money management. A lower score may pass the credit-score test, but necessitate a higher interest rate to compensate for the greater risk.
Above and beyond credit, approvals will be issued to applicants who can provide proof of earnings which may involve some or all of the following documentation. Income verification is required to establish required Debt to Income percentages.
- 30 day’s pay stubs
- 2 year’s W2s
- 2 year’s tax returns if self-employed
- An offer letter, if not yet started
- Proof of education for new graduates
Most lenders require a two-year documentation to show a consistent earnings stream,. Maintenance, also termed alimony, can also be counted if documented in a divorce decree, along with the recurring method of payment such as automatic deposit. Seasonal income is also accepted, again with proof in a tax return.
Conventional loans actually come with less strict appraisal and property requirements than do FHA, VA or USDA loans. This is another advantage to conventional: you can qualify for a home in slightly worse condition and plan to make the repairs after your loan is approved and you move in.
Mortgage Insurance–PMI (Private Mortgage Insurance)
Private mortgage insurance, or PMI, is required for any conventional loan with less than a 20% downpayment.
PMI rates vary considerably based on credit score and downpayment.
For instance, one PMI company is quoting the following rates, as of the time of this writing, for a $250,000 loan amount and 5% down.
- 740 credit score: $123 per month
- 660 credit score: $295 per month
And these are quotes for a 10% downpayment:
- 740 credit score: $85 per month
- 660 credit score: $208 per month
High PMI rates for lower credit scores prompt many buyers to use an FHA loan. Unlike conventional loans, FHA loans do not charge higher mortgage insurance rates, even for applicants with very low scores.
Simply put, a borrower’s DTI ratio measures the borrower’s monthly debt against his or her gross monthly income. It’s expected and common to have some debt.
The potential buyer’s debt-to-income ratio also plays a factor since it, too, can reveal good or poor financial prudence.
When it comes to buying a house, lenders factor in all debt to determine the total mortgage payment, including the loan, homeowner’s insurance, and real estate taxes.
Many lenders want this ratio to be less or equal to 36 percent of the borrower’s income.
The maximum can be exceeded up to 45% if the borrower meets the credit score and reserve requirements and larger downpayment reflected in the Eligibility Matrix..
But many lenders will issue loans up to a forty-three percent debt-to-income ratio, the limit set by recent federal legislation.
With a good credit score, you can qualify for more house and a bigger payment than you probably think.
Closing costs will involve fees such as a lender’s origination fee plus vendor fees like the appraisal, title insurance, and credit reporting fees. There will be prorations on property taxes and HOA. There are also pre payment for property tax, home owners insurance and HOA .
Sometimes, a lender or seller will pay all or some of these expenses depending on the strength of the market and desire to close the transaction.
Typically, sellers and other interested parties can contribute the following amounts, based on the home price and downpayment amount.
- Less than 10% down: three percent of the purchase price
- 10 to 25% down: six percent of the purchase price
- More than 25%: nine percent of the purchase price
When buying a rental or investment property, the seller can contribute only two percent with any downpayment amount.
- If you put down 20% or more, it can all be from a gift.
- If you put down less than 20%, part of the money can be a gift, but part must come from your own funds. This minimum contribution varies by loan type.
- You can only use gift money on primary residences and second homes.