What is a conventional mortgage?

Conventional loan rate home mortgage

The most common type of mortgage not backed by the government is a conventional loan. This type of loan meets the standards to be offered to the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), two government-sponsored enterprises. In most cases, conventional mortgages have a fixed rate of interest, which means that the interest rate does not fluctuate over the life of the loan. Because conventional mortgages or loans are not backed by the federal government, banks and creditors often have higher lending standards.

The Federal Housing Administration (FHA), the United States Department of Veterans Affairs (VA), and the USDA Rural Housing Service, are just a few of the government entities that offer other types of mortgages.

 

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Conventional Loan Requirements

Conventional loans are frequently referred to as conforming mortgages or loans, which is incorrect. While there is some overlap, the two categories are separate. A conforming mortgage is one whose underlying terms and conditions satisfy Fannie Mae and Freddie Mac’s funding criteria based on the loan amount. A Conforming loan is referring to the loan amount being less than the Jumbo loan amount. The Federal Housing Finance Agency sets a yearly dollar cap for Jumbo loans and a conforming mortgage must be under that loan amount.

Down payment for conventional mortgages

The minimum down payment for a conventional mortgage is 3%, however, there are several limitations such as income, a requirement to be a first-time home buyer, as well as debt to income ratio maximums. If these requirements can’t be met, the minimum down payment is 5%. However, keep in mind, the down payment can be a gift from an acceptable source, essentially allowing the home buyer to purchase a home without a down payment of their own.

  • If you’re interested in an adjustable-rate mortgage loan, you’ll need a 5% down payment.
  • For purchases of multi-unit properties, a down payment of 15% or more may be required.
  • Purchases of second homes, a down payment of at least 10% is required.
  • You’ll need to leave at least 20% equity in your property if you’re doing a cash-out refinance loan.
  • You’ll need 10.01–25 percent equity to refinance a jumbo loan, depending on the loan amount.
 

Private Mortgage Insurance for Conventional Mortgages

With a conventional loan, , if you put down less than 20%, you’ll have to pay for private mortgage insurance (PMI). In the event that you default on your loan, PMI protects your lender. PMI costs vary depending on the type of loan, your credit score, and the size of your down payment.

PMI is often included in your monthly mortgage payment, but there are other options for covering the expense. Some buyers pay it as a one-time payment. Others will pay it with a slightly higher interest rate. Make sure you understand the numbers so that you select the most cost-effective choice for you.

PMI has the advantage of not being a permanent element of your loan – you won’t have to refinance to get rid of it. You can ask your  mortgage lender to eliminate the PMI from your mortgage payments once you have 20% equity in your house and are making regular mortgage payments. If your home’s value rises to the point where you have 20% equity, you can contact your lender for a new appraisal so they can eliminate your PMI based on the new value. Your lender will automatically remove PMI from your loan after you have 22% equity in your property.

What are the disadvantages of a conventional mortgage? 

Conventional mortgages often have stricter credit requirements and debt-to-income ratios. These two considerations limit Fannie Mae and Freddie Mac’s risk, making this sort of loan more difficult to obtain for people with lower credit scores.

The minimum credit score for a Conventional mortgage is 620. However, without a large down payment, it is very difficult to get approved with a score below 680. The standard automated underwriting system will evaluate the overall credit profile and will look at assets, debt to income, down payment and job history to assess the likelihood a lower credit score obtains an approval. So, the main disadvantage of a Conventional mortgage is the more difficult standards for an approval.

 Is it harder to qualify for a conventional loan?

Conventional loans are often more difficult to qualify for than FHA loans due to tougher credit score standards and lower debt-to-income ratios requirements. With a credit score in the upper 600s, a conventional loan is possible. Most people may qualify for a conventional loan because the average credit score in the United States is 698.

The following are typical qualification requirements:

  • A debt-to-income ratio of less than 43% (perhaps lower if you don’t have excellent credit) but it’s possible up to 50%.
  • A credit score of at least 620 is required.
  • A minimum 3% down payment is required (20 percent if you want to avoid paying for mortgage insurance) and as much as 5%.

Because many Conventional loans are sold to government agencies such as Fannie Mae and Freddie Mac, lenders often assume little risk on individual loans and are able to offer better rates.

What are the pros and cons of a conventional loan?

Approximately 64% of all home loans are Conventional mortgages. Conventional mortgages are issued by banks and other Greenville SC mortgage lenders and are commonly sold to government-sponsored entities, such as Fannie Mae and Freddie Mac.

Conventional loans, despite being the most common, are more difficult to obtain. Borrowers must have a credit score of at least 620 and a debt-to-income ratio of 50% or less to qualify. With a 620 credit score, however, getting approved for a conventional loan is extremely improbable unless the person has a hefty down payment or a significant quantity of assets. Borrowers must be able to afford a 20% down payment in order to avoid paying private mortgage insurance (PMI).

The following are some more advantages and disadvantages of conventional loans:

Pros:

  • Competitive interest rates are available. Mortgage rates have plunged to unprecedented lows in the middle of the COVID pandemic.
  • You can get a conventional loan with as little as a 3% down payment. Many individuals believe that a 20% down payment is required, but this is not the case. Although PMI is required for loans with less than 20% down, PMI can be eliminated.
  • PMI is usually waived once you have 20% equity in your house, based on the appraised value.
  • A fixed-rate 30-year mortgage is the most common Conventional loan. Fixed-rate mortgages have the advantage of locking in today’s record low interest rates, but adjustable-rate mortgages are a good option if you don’t plan to keep your mortgage for more than a few years.
  • Conventional loans can be used for a variety of purposes. Conventional loans can be utilized for a primary residence, a vacation home, or a rental property, unlike FHA loans, which are confined to principal residences.
  • A conventional loan’s maximum loan amount is higher than an FHA loan’s maximum loan amount.

Cons:

  • Credit score standards are more stringent than those for government-backed loans.
  • Although conventional loans allow a 620 score, unless the individual has many compensating factors, it is highly unlikely to get an approval with a credit score under 680. 
  • Even if you qualify with a lower score, your interest rate will be significantly higher than if you had stellar credit. Debt to income (DTI) requirements on conventional loans are stricter than those required with other types of loans. 
  • A DTI up to 50% is allowed, but the overall credit profile has to be stellar to get an approval.  Also, the cost of PMI is higher with lower scores and/or higher DTI’s.
  • The waiting period after bankruptcies and foreclosures is significantly longer than an FHA home loan or VA home loan.
 

What qualifies you for a Conventional loan? 

Conventional Loans require a down payment of either 3% or 5% and a minimum score of 620. Additionally, the debt-to-income ratios should be between 45% and 50% and the overall credit profile should exhibit a good pay history. Without higher credit scores, expect to need a large down payment to receive an approval. Your lender will need to verify everything you provide on your application, including your income, work history, assets, as well as a credit report. This is required by the Lender in order for you to be able to verify your ability to repay your loan.

Fannie Mae and Freddie Mac have imposed some minimum conditions for all conventional loans however, each Lender has the ability to apply its own, stricter rules, which are referred to as “lender overlays” in the industry. Lenders are not allowed to impose rules that might be considered discriminatory in the mortgage industry.

These are the minimal conventional loan standards you should be aware of as a Borrower:

  1. A credit score of at least 620 is required.
  2. Maximum debt-to-income (DTI) ratio of 45 percent, with the possibility of approval up to 50%.
  3. Property appraisal verifying the home’s value and condition.
  4. Minimum down payment of 3%, or 20% to eliminate PMI
 

Documentation for a Conventional loan application

  1. For a conventional loan application, you’ll need the following items:
  2. Your driver’s license or another kind of photo identification.
  3. A month’s worth of pay stubs (if you’re a W-2 employee).
  4. Tax returns from the previous two years.
  5. Two months bank statements showing your funds for down payment.
  6. Most recent retirement statement if needed.

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Conventional Loan FAQs

It is a common misconception that in order to obtain a conventional loan, you must pay a 20% down payment, but that is not the case. In fact, you can qualify for a conventional loan by putting down as low as a 3% down payment.

It is possible to refinance a conventional mortgage to an FHA loan. According to the FHA loan handbook, HUD 4000.1, there are several options for FHA refinancing, including non-FHA to FHA transactions: No cash-out refinances of FHA-insured and non FHA-insured Mortgages are designed to pay existing liens.

Can I get a mortgage with 3% down? Yes! The conventional 97 program allows 3% down and is offered by many lenders. Fannie Mae’s HomeReady loan and Freddie Mac’s Home Possible loan also allow 3% down with extra flexibility for income and credit qualification.

Yes, with a Conventional loan the down payment can be as little as 3%. However, if not approved for 3% down, 5% is the minimum. Anytime there is a payment below 20%, PMI will be required.

The term on a Conventional loan can be fixed or an Adjustable Rate Mortgage (ARM). Most Conventional loans are fixed terms.

One of the main requirements for a conventional loan is that the home must be appraised. However, depending on the credit profile and the down payment, a Property Inspection Waiver may be granted and an Appraisal not required.

If you’re looking for an exact number, according to Ellie Mae’s October 2019 Report, it’s 47 days. This reflects the average time from loan application to funding for three common types of loans. Broken down even more, that’s 47 days for an FHA loan, 46 days for a Conventional loan and 49 days for a VA loan. However, a Conventional loan can be typically be closed in 30 days.

Conventional loans that are guaranteed by Fannie Mae or Freddie Mac will require you to live in the house for one year or more before you can rent it out. Lenders may also have other restrictions on the use of the property, so it’s better to call them first before renting out your home.

The short answer is that you can have up to 10 conventional mortgages in your name at once. However, in practice, experienced real estate investors know it’s possible to use alternative financing methods to take on even more mortgage debt.

A conventional loan is a great option if you have a solid credit score and little debt. In most cases, borrowers save money in the long run with a conventional loan because there’s no upfront mortgage insurance fee, and the monthly insurance payments are cheaper.

Even though a conventional loan is the most common mortgage, it is more difficult to get. Borrowers need to have a minimum credit score of at least a 640 in order to qualify and generally above 680.

The minimum down payment required for a conventional mortgage is 3%, but borrowers with lower credit scores or higher debt-to-income ratios may be required to put down more. If 3% down isn’t an option, the minimum is 5%.

A disadvantage to conventional lending is generally lower debt-to-income ratios are required. Low income and high debt scenarios pose additional risk to private lenders, therefore debt ratio requirements are more stringent with conventional loans.

A conventional loan is used to finance the purchase of either your primary residence, secondary residence, or a rental property. The down payment requirement will vary based on the intended usage.

Some sellers will have their home listed on the market allowing only a Cash or Conventional loan buyer to make offers on it. The usual reason for this is because the appraisal done on an FHA or VA loan is a little more stringent with it’s requirements for the property to meet the government FHA or VA standards.

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