What is a Conventional Loan?
A conventional loan is a mortgage that is not backed by any Government agency such as the Federal Housing Administration (FHA) or Veterans Administration (VA).
Conventional loans meet the lending requirements of Fannie Mae and Freddie Mac, the two largest buyers of mortgage loans in the US.
Most conventional mortgages are issued by private lenders who then sell the loan to one of these Government Sponsored Entities (GSE’s).
Conventional Loan Requirements
Credit- The minimum credit score requirement is typically between 620-640 depending on the lender.
Occupancy- Conventional loans can be used to finance a primary residence, a second home, vacation property or a rental property. This is in contrast to government-backed loan programs which can only be used to finance a primary residence.
Property Type- Single-family homes, duplexes, 2-4 unit properties,condominiums and townhouses are eligible.
Income- Income will be verified by reviewing recent pay check stubs, tax returns and W2s. Debt-to-income ratio must not exceed 43%.
Assets- Bank and investment statements will be verified to ensure the borrower has sufficient assets to close. These funds must be able to cover a down payment plus associated closing costs.
Types of Government-Backed Loans
Government-backed loans are issued by private lenders and guaranteed by the Federal Government with programs such as FHA or VA.
Conventional loans are not insured by the government but by private mortgage insurance companies.
FHA Loans – An FHA mortgage is popular for it’s low 580 credit score requirements and 3.5% down payment.
VA Loans – VA loans are for Veterans, they come with no downpayment or mortgage insurance.
USDA Loans – The Department of US Agriculture created the USDA guaranteed loan program for low-to-median income homebuyers in rural areas of the country.
Conventional Loan Pros and Cons
- Higher loan limits than FHA
- Adjustable-rate and fixed-rate loan terms available
- No private mortgage insurance (PMI) with 80% loan-to-value ratio
- Available for second homes and investment properties
- PMI cancels when the LTV reaches 78%
- Lower PMI rates than FHA
- Conventional 97 with 3% down
- Credit score requirement is higher than FHA (minimum 620-640)
- Higher down payment requirement (5%-20%)
- Qualifying guidelines are more strict
- Low income borrowers may not qualify
A conventional loan may be a good fit for you if…
- Minimum Fico credit score of 620
- Have a 20% down payment
- Want to avoid PMI by putting at least 20% down
- Have a high income (low debt-to-income ratio)
- Need a loan amount that is above the FHA loan limit
Down Payment Guidelines
There are no standard down payment guidelines for conventional financing. The minimum down payment is usually between 5% – 20% of the sales price.
The conventional 97 loan offers 97% financing, requiring just a 3% down payment.
Conventional mortgage loans with less than a 20% down payment and the mortgage is greater than 80% of the value of the home a private mortgage insurance policy is required.
A private mortgage insurance policy, or PMI, is an insurance policy that compensates the lender the difference between the 80% threshold and the amount of down payment should the loan ever go into default.
Conforming loans are mortgage loans that are underwritten to standards issued by Government-backed entities Fannie Mae and Freddie Mac and make up more than half of all mortgages issued today.
Loans that do not meet these requirements are non-conforming loans. This includes jumbo loans, portfolio loans, and investor loans.
Conventional loans make up over 60% of all home loans issued in the US.
If you have a 20% down payment you can enjoy low interest rates and avoid mortgage insurance saving you thousands per year.
With their higher credit score requirements conventional loans are more difficult for first-time homebuyers to qualify for.
Conventional vs FHA Loans
FHA Loan Advantages
- Easier to qualify for because of their low credit score and down payment requirements
- Require just a 3.5% down payment making them an attractive option for first-time home buyers
- Borrowers with a 580 credit score may qualify with just a 3.5% down payment
- Higher DTI ratios accepted making them better for low-income borrowers
FHA Loan Disadvantages
- FHA loans require mortgage insurance regardless of the down payment
- In some cases PMI is required for the life of the loan
- Limited to buying only homes that are approved for an FHA loan
- Properties in need of repair will not qualify
- May have higher interest rates
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