One of the first decisions you'll make while looking for a property is what form of mortgage you'll get.
Conventional mortgages, which are not guaranteed by any government body, are by far the most popular choice among borrowers. They can be used to buy or refinance a home and are generally available from most mortgage institutions.
The popularity of conventional mortgages stems from their flexibility and widespread availability. These loans cater to a broad range of borrowers, from first-time homebuyers to seasoned real estate investors. Unlike government-backed loans, conventional mortgages can be used for various property types, including primary residences, vacation homes, and investment properties. This versatility makes them an attractive option for many prospective homeowners who want to explore different real estate opportunities.
Are you planning to apply for a home loan? Here's what you should know about conventional loans.
Types of conventional mortgages
Conventional mortgages can be classified into two types: conforming and non-conforming. The primary distinction between these two sorts is the amount of money required to borrow and the qualifying standards.
Conforming loans
A conforming mortgage fulfills the Federal Housing Finance Agency's (FHFA) conforming loan limit and the standards for purchase by Fannie Mae or Freddie Mac. The FHFA determines the conforming loan maximum each year. Most portions of the United States will have a $766,550 cap in 2024. In higher-cost areas, the cap increases to a maximum of $1,149,825.
To acquire a conforming loan, you must meet certain qualifying standards established by Fannie and Freddie. You'll need a credit score of at least 620 and a debt-to-income ratio of 45% or lower.
It's important to note that while these are the general guidelines, individual lenders may have their own overlays or additional requirements. Some lenders might require higher credit scores or lower debt-to-income ratios, especially in competitive housing markets. Additionally, factors such as employment history, income stability, and assets can also play a significant role in the approval process for conforming loans.
Nonconforming loans
A nonconforming mortgage does not meet these requirements. One of the most popular types of nonconforming mortgages is a jumbo loan, which is one that exceeds the conforming loan limit.
Non-conforming loans provide lenders more flexibility in who they can lend to, so you may be able to acquire a loan with a lower credit score, a larger debt-to-income ratio, or non-traditional income. (However, because of the bigger amount of money on the line, higher-limit jumbo loans often have more severe standards).
Advantages of traditional mortgages
Conventional loans offer numerous advantages over other mortgage types. This includes:
Flexibility
Conventional loans are less standardized than government-backed loans, allowing for far greater freedom. You'll find a broader selection of terms, borrowing restrictions, and possibilities.
No mortgage insurance
If you can put down 20%, you won't need mortgage insurance with a traditional mortgage. This can result in significant savings over the length of your loan term. FHA loans usually demand mortgage insurance (both up front and as part of the monthly payment).
Lower closing fees
Because commercial loans do not have as many upfront fees as government loans, you may be able to pay fewer closing costs.
Faster processing
Government-backed mortgages have a lot of red tape, which can make them take longer to process and underwrite. A conventional loan may allow you to close more quickly.
Another significant advantage of conventional mortgages is the potential for better interest rates, especially for borrowers with excellent credit scores. As conventional loans are not backed by government guarantees, lenders often offer more competitive rates to attract qualified borrowers. This can translate to substantial savings over the life of the loan. Furthermore, conventional loans typically allow for more creative financing options, such as piggyback loans or home equity lines of credit, which can be beneficial for borrowers looking to avoid private mortgage insurance or access additional funds for home improvements.
Conventional mortgage criteria
The eligibility requirements for a conventional mortgage are often divided into three categories: credit score, debt-to-income ratio, and down payment.
If you don't fulfill all three requirements, you should see if you qualify for a government-backed mortgage or wait to buy a property. With additional time, you can boost your credit score, pay off debt, or save more for a down payment.
Credit Score
The lowest credit score required to buy a house is 620 for a conforming conventional loan, while individual lenders may require higher scores. A nonconforming loan will likely require a credit score of 700 or above.
Debt/income ratio
Your debt-to-income ratio (DTI) is calculated by dividing your monthly debt payments by your gross monthly income. For example, if you pay $2,000 per month for your mortgage and student loan payments and make $3,000 per month, your DTI ratio is $2,000 divided by $3,000, or 66%.
When you apply for a mortgage, your projected future mortgage payment is considered in the computation. You can qualify for a conforming conventional mortgage with a total DTI percentage of up to 50%. However, the maximum DTI you can have is determined by your complete financial profile, which includes your credit score and down payment amount. To increase your chances of approval, keep your DTI around 36%. If you're applying for a jumbo loan, a DTI of more than 45% is likely to make it more difficult to qualify.
Down payment
For conforming loans, the minimum down payment is 3%, however other lenders may require 5% or 10%. Jumbo loans may require 10% or more, though this varies by lender.
If you put less than 20% down on a conforming loan, you must pay for private mortgage insurance until you have 20% equity in the home. This monthly fee will be added to your mortgage payment. According to Freddie Mac, you should expect to pay between $30 and $70 per month for every $100,000 borrowed.
documents: Provide financial documents to your lender to demonstrate your ability to pay. This often contains tax returns, W-2 forms, bank statements, pay stubs, and other documents.
Conventional mortgages versus alternative lending kinds
A conventional mortgage, often known as a conventional loan, is one that is not government-insured or guaranteed.
A private lender, such as a bank, nonbank mortgage lender, or credit union, will provide you with a traditional mortgage. Although the government does not insure these loans, many conventional mortgages are backed by government-sponsored firms such as Fannie Mae and Freddie Mac. Following the closing, one of these corporations will acquire the mortgage.
In contrast, a government-backed mortgage includes insurance or guarantees that a federal agency, such as the Federal Housing Administration, the United States Department of Agriculture, or the Department of Veterans Affairs, will cover a portion of the mortgage if the borrower defaults. Here's how they vary from conventional loans.
FHA loans: FHA loans sometimes allow for lower credit scores than conventional loans (down to 500 in some situations), but also require a greater down payment (at least 3.5% versus 3% for normal loans). They also require mortgage insurance up front and throughout the loan duration.
VA loans are available solely to veterans, military members, and their spouses. They do not require a down payment, however there is an initial funding cost.
USDA loans are only available for the purchase of properties in qualified rural areas of the country, and you must have a low to moderate income in your area to qualify. No down payment is necessary, but there is an initial guarantee fee.
While government-backed loans offer certain advantages, particularly for borrowers who might not qualify for conventional mortgages, they come with their own set of limitations. For instance, FHA loans have loan limits that can be restrictive in high-cost areas, and the mandatory mortgage insurance can significantly increase the overall cost of the loan. VA loans, while beneficial for eligible borrowers, may have stricter property requirements and can sometimes be less attractive to sellers in competitive markets. USDA loans, despite their zero down payment feature, are limited to specific geographic areas and have income restrictions that may exclude many potential borrowers.
How to Get a Conventional Mortgage
Conforming, conventional mortgages are the most common mortgage product available, so if you're thinking about getting one, you're not alone. Here's how to obtain one:
Step one: Check your credit.
Before you apply for a loan, check your credit report to see what score you have. The higher your score, the easier it is to qualify (and the lower your interest rate). If it is on the lower end, you should work on improving it before applying.
Step 2: Save for a downpayment.
To qualify for a traditional loan, you must make at least a 3% down payment; however, anything less than 20% will result in monthly payments for private mortgage insurance. According to Freddie Mac, the monthly cost ranges between $30 and $70 for every $100,000 financed.
Step three: Get pre-approved.
Getting pre-approved with a mortgage lender will help you determine how much you may borrow, what rate you can expect, and what price range you should shop in. Compare preapproval offers from multiple lenders to obtain the best deal.
Step 4: Fill out the application and supply documentation.
Finally, you must complete your lender's comprehensive application and give any requested financial documentation. Maintain regular communication with your loan officer until closing day, when you will pay your closing expenses and down payment and sign the final papers.
It's crucial to remember that the mortgage landscape is constantly evolving, influenced by economic conditions, regulatory changes, and market trends. Prospective borrowers should stay informed about current mortgage rates, loan programs, and industry developments. Additionally, working with a knowledgeable mortgage professional can provide valuable insights and guidance throughout the loan application process. They can help you navigate the complexities of conventional mortgages, explain the nuances of different loan options, and assist in finding the most suitable mortgage product for your specific financial situation and homeownership goals.
