In this article, we will cover understanding conventional loans. Conventional loans are the most popular traditional loan program in the nation. Homebuyers of owner-occupant homes, second homes, and investment properties can use conventional loans to finance their property. Marga Jurilla of Gustan Cho Associates explains conventional loans.
Conventional loans are referred to as conforming loans because they need to conform to Fannie Mae or Freddie Mac agency guidelines. Conventional loans are not backed by a government agency like HUD, VA, and USDA.
As a potential homebuyer, understanding the various types of loans available to you can be instrumental in making an informed decision regarding financing your home. When considering home loans, you may encounter the term conventional loans. So, what exactly are conventional loans, and how do they differ from other types?
What Are Conventional Loans?
This section will discuss the difference between conventional loans and other mortgage programs. A conventional loan is a mortgage not insured or guaranteed by government agencies like the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), or USDA. Instead, the lender assumes the risk of the borrower’s ability to repay the loan.
Private mortgage insurance is required on conventional loans if the borrower has higher than an 80% loan-to-value. Private mortgage insurance premiums depend on the borrowers credit profile.
Private mortgage insurance decreases if the borrower has at least 80% loan-to-value. Private mortgage insurance is not required on conventional loans if the borrower has at least 20% equity.
Conventional Loans Versus Other Mortgage Loan Options?
How are conventional loans different from other types of loans? Conventional loans differ from other types of loans in several ways. One significant difference is that a government agency does not back conventional loans. It means the lender assumes the risk of lending to the homebuyer rather than the government.
A government agency like FHA, VA, or USDA does not back conventional loans.
Also, conventional loans typically require a higher credit score and a larger down payment than other loan types. For example, an FHA loan may only require a minimum credit score of 500, while a conventional loan may require a score of 620 or higher.
Eligibility Requirements on Conventional Loans
Who qualifies for a conventional loan? To qualify for a conventional loan, you must meet specific criteria, such as having a stable income, a good credit score, and a down payment of at least 3-5% of the home’s purchase price. The requirements will vary depending on the lender and the type of conventional loan you’re applying for. Several factors impact qualification for a conventional loan. Several factors can affect your eligibility for a conventional loan, including credit scores, debt-to-income ratio, and other risk factors.
Minimum Credit Score Requirements on Conventional Loans
Credit score: Your credit score is significant when applying for a conventional loan. A higher score will improve your approval chances and could lead to a better interest rate. The minimum credit score required on conventional loan loans is 620 FICO.
Debt-To-Income Ratio Guidelines on Conventional Loans
Debt-to-income ratio is the amount of debt you have compared to your income. A lower debt-to-income ratio will improve your chances of being approved for a conventional loan. There is no front-end debt-to-income ratio cap on conventional loans. The maximum back-end debt-to-income ratio is 50% on conventional loans.
Down Payment Requirements on Conventional Loans
Down payment: The minimum down payment requirement on conventional loans is 3% for first-time homebuyers. Homebuyers with ownership in a home in the past three years require a 5% down payment. Second homes require a 10% down payment. Investment properties require a 15% to 20% down payment.
The higher the down payment homebuyers put down on conventional loans, the lower the mortgage rates.
The amount you can put down on the home will impact your eligibility for a conventional loan. A larger down payment will generally improve your chances of being approved. Employment status: Lenders will want to see that you can afford the monthly mortgage payments with a stable source of income.
Benefits of Conventional Loans
While conventional loans have some benefits, there are also drawbacks that potential homebuyers should be aware of. Some of the benefits of conventional loans include the following:
- Lower interest rates: Conventional loans often offer lower rates than other loans.
- More flexibility: There are various conventional loan programs available, including fixed-rate, adjustable-rate, and interest-only loans. It offers more flexibility and options for homebuyers.
- No mortgage insurance: Unlike other types of loans, conventional loans don’t require mortgage insurance if a borrower can pay a larger down payment.
Drawbacks Of Conventional Loans
Some of the disadvantages of conventional loans include the following:
Higher credit score requirement:
- Conventional loans often require a higher credit score, which can be challenging for some homebuyers.
Larger down payment requirement:
- Usually, conventional loans require a down payment of at least 3-5% of the purchase price, which can be a significant financial burden for many homebuyers.
Strict eligibility criteria: Conventional loans often have strict eligibility criteria that borrowers must meet, including a good credit score, good employment history, and a low debt-to-income ratio.
Benefits of Conventional Versus Other Loan Programs
When is it better to choose a conventional loan over other types of loans? Choosing a conventional loan over other types of loans may be better in certain situations. For example, you can secure a lower interest rate with a conventional loan if you have a high credit score. If you give a larger down payment, you can avoid mortgage insurance and save money in the long run. A conventional loan may be your best option if you don’t qualify for other types of loans, such as VA loans.
When is it Better To Avoid Conventional Loans?
There are specific situations where it may be better to avoid conventional loans. You may only qualify for a conventional loan or be charged a higher interest rate if you have a high credit score. If you don’t have a large down payment, you may be required to pay mortgage insurance, which can add additional costs to your monthly mortgage payment. A conventional loan may offer different benefits if you' re looking for specific loan programs or benefits, such as those offered by VA or FHA loans.
Documentation Required For a Conventional Loan Application
If you’re considering applying for a conventional loan to purchase a home, it’s essential to understand the loan application process and what documentation and financial preparation are required. The documentation needed for a conventional loan application typically includes the following:
- Income verification: This includes W-2s or 1099s, pay stubs, and proof of any additional income, such as rental income or alimony.
- Asset verification includes bank statements, investment statements, and information on any other assets you have.
- Employment verification: Lenders will want to see proof of your employment and income to ensure that you have a stable source of income to pay the loan.
- Credit report: Lenders will obtain a copy of your credit report to review and check your payment history and credit scores.
- Appraisal: Lenders will require a home appraisal to determine your purchase property value.
Preparing Your Finances For a Loan Application
Before applying for a conventional loan, you can take several steps to prepare your finances. Check your credit score: Your credit score is a significant factor in your loan application. Review your credit score and report, and take steps to improve your score if necessary. Pay off debt: A lower debt-to-income ratio will improve your chances of loan approval. Consider paying off any outstanding debts before applying for a loan. Save for a down payment: A larger down payment will help lower your monthly mortgage payments and improve your chances of loan approval. Gather all necessary documentation before applying for a loan to ensure a smooth application process.
What You Can Expect During The Loan Application Process
The loan application process typically includes the following steps:
Pre-approval:
- The preliminary step in the loan application process involves submitting basic financial information to a lender to determine how much you may be eligible to borrow.
Application:
- Once you’ve found a home and have a purchase agreement, you’ll submit a formal loan application to the lender.
Processing:
- The lender will review your application and documents to determine your eligibility for a loan.
Underwriting:
- Once the loan is processed, an underwriter will screen your application to ensure you meet all eligibility requirements.
Closing: If your loan is approved, you’ll attend a closing meeting to sign all necessary documents and finalize the loan.
Common Mistakes to Avoid During The Mortgage Application Process
To ensure a smooth loan application process, avoid these common mistakes. Making significant changes to your credit profile, such as opening a new credit card or taking on new debt, during the loan application process. Failing to disclose all necessary information on your application. Missing deadlines, failing to submit all required documentation on time, and not shopping around for the best interest rates and loan options. Choosing the right conventional loan program can be a critical decision for homebuyers. Several lenders offer conventional loans with varying requirements, eligibility criteria, and benefits. Therefore, it’s essential to understand the loan programs and their requirements before choosing.
Basic Conventional Loan Options and Requirements
The two main types of conventional loans are fixed-rate and adjustable-rate mortgages (ARM). Fixed-rate mortgages have an interest rate that remains the same throughout the loan term, while ARMs have an interest rate that changes over time. Mike Gracz
Conventional loans also have a High Balance loan limit that exceeds the standard loan limit. This type of loan is ideal for homebuyers who want to purchase a more expensive home, as it provides a larger loan amount that goes beyond the standard one. The basic requirements for conventional loans include a minimum credit score of 620, a down payment of 3% to 20%, and a debt-to-income (DTI) ratio of 43% or lower.
Understanding Mortgage Rates and Fees for Conventional Loans
Interest rates and fees for conventional loans vary based on the lender, loan program, and creditworthiness of the borrower. The interest rates might be fixed, adjustable, or fluctuate with the market.
Other fees that come with conventional loans include origination fees, discount points, and closing costs. Your lender will explain the fees charged under each loan program and ensure you understand how they’ll impact your total loan amount.
How To Choose the Best Lender To Suit Your Needs
Working with a mortgage lender to identify the best loan program for you is important. Choosing the best loan program can be challenging, but working with a mortgage lender can help simplify the process.
A mortgage lender can assist you in understanding the different loan programs and help you find one that suits your financial situation.
A mortgage lender can also pre-approve you for a loan and give you a clear idea of how much you can afford. Additionally, they can help you understand the fine print of specific loan programs and estimate the monthly payments that come with each program.
Fannie Mae Debt-To-Income Guidelines on Conventional Loans
This section will cover understanding the monthly mortgage payment and how to calculate it. A crucial step in securing a conventional loan is to understand the monthly mortgage payment and how to calculate it. Your monthly mortgage payment will depend on several factors, including the loan amount, interest rate, and loan length.
Gustan Cho Associates has no lender overlays on the debt-to-income ratio on conventional loans. The maximum debt-to-income ratio of conventional loans is 50/50. There is no front-end debt-to-income ratio on conventional loans.
You’ll need to use a mortgage calculator or a formula that factors in the loan amount, interest rate, and loan length to determine your monthly payments. Your mortgage payment may include additional fees such as property taxes, homeowners insurance, and private mortgage insurance.
Private Mortgage Insurance
Budgeting accordingly for your monthly mortgage payment and any associated fees is vital to ensure you can afford to make timely payments on the loan—strategies for improving your credit score.
HUD requires a one-time FHA mortgage premium of 1.75% one time upfront and a 0.55% lifetime annual mortgage premium for 30-year fixed-rate mortgages. Private mortgage insurance premium depends on the borrowers credit strength and credit scores. Fannie Mae and Freddie Mac doesn’t have a one-time upfront private mortgage insurance premium.
Your credit score is a significant factor in securing a conventional loan. To improve your credit score, consider implementing the following strategies. Pay off outstanding debts: A lower debt-to-income ratio can improve your credit score. Pay bills on time: Timely payment of your accounts can improve your credit history and, thus, your credit score. Review your credit report: Regularly review your credit report to help identify potential errors or areas where you can improve your score.
Tips for Getting The Best Rates for Your Loan
Consider these tips to secure the best interest rate for your conventional loan. Shop around: Compare interest rates from different home lenders to find the best rate that suits your financial situation. Improve your credit score: A better credit score could lead to a lower interest rate. Increase your down payment.
Home-buying can be lengthy and require extensive documentation, so knowing the various milestones and requirements is essential. After closing on your home, you’ll be responsible for making timely mortgage payments and maintaining the property. Additionally, it’s essential to budget for any unforeseen expenses, such as repairs or maintenance.
Why Conventional Loans Are Popular
Conventional loans are a popular financing option for home buyers due to their flexibility, various loan programs, and lower interest rates than other loans.
Understanding the benefits and drawbacks of conventional loans is essential to make an informed decision when financing a home. Preparing your finances, gathering the necessary documentation, and working with a trusted mortgage lender can simplify the loan application process and lead to a successful home purchase.
Remember, every buyer’s financial situation is unique, and we at Gustan Cho Associates can help you identify the best loan program to suit your needs. Give us a call today!