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Conventional mortgages make up the majority of all home loans, about 64% in total. Conventional mortgages are issued by banks and other lenders and are often sold to government backed entities like Fannie Mae and Freddie Mac.
Even though a conventional loan is the most common mortgage, it is surprisingly difficult to obtain. Borrowers must have a minimum credit score of around 640 to qualify (the highest minimum score of all mortgage products) and have a debt-to-income ratio of 43% or less. Borrowers should also be able to make a down payment of 20% or more in order to avoid mortgage insurance.
What is a conventional mortgage loan?
A conventional loan is a type of mortgage it’s made for residential property. These loans are issued by private lenders (banks, credit unions and other lenders). Lenders who provide conventional loans also service the loans, which means they collect the mortgage payments and sue foreclosure if a borrower defaults.
Conventional mortgages are not guaranteed by the government, like the USDA or FHA loan. However, for a home loan to qualify as a classic home loan, it must comply with the credit rules set by Fannie Mae and Freddie Mac. These rules require:
- A minimum credit rating around 640 to qualify, depending on loan size, debt-to-income ratio and other factors
- A debt to income ratio less than 43% – may be lower for borrowers with a lower credit score
- No major credit report issues, such as bankruptcy or foreclosure
- A down payment of 3% or more (20% if you don’t want to buy mortgage insurance)
- A total loan amount of $ 510,400 or less (in most areas – $ 765,600 in higher cost areas)
The loan limit for conventional mortgages varies by location. For 2020, the limit in most areas is $ 510,400. However, for higher cost areas, the limit can be as high as $ 765,600.
How a conventional mortgage works
Getting a conventional loan can be a slow process. There is a lot of paperwork and documentation that you will need to provide. But the process for obtaining a conventional loan is actually relatively straightforward.
The process begins when you apply for a mortgage. You will work with a loan officer to complete your application and provide the relevant financial documents. When your loan is approved, you close, which is when you actually get your loan.
When you take out a mortgage, the lender who issues your loan takes a mortgage lien on your house, which gives them a secured interest on the property. When you have a mortgage, you cannot sell or borrow the property without permission from the lender. If you stop paying your mortgage, the lender can sell the property to collect the outstanding loan balance.
Required documents you will need to apply for a mortgage
Before approving your loan, your lender will need to document everything you put on your application, including your income, debts, assets, and credit rating. The lender requires it to make sure you are earning enough money to pay your loan.
The seven documents you will need are:
- Your driver’s license or other photo ID
- Last month’s pay stubs (if you are a W2 employee)
- Tax returns for the last two years
- Documentation to show how you will make your down payment
- A financial statement that shows assets and liabilities
- Your credit report, which your lender will order
- A Evaluation of the property borrowed against
Who is eligible for a conventional loan?
Standard qualification requirements include:
- A debt-to-income ratio of less than 43% (potentially lower if you don’t have good credit)
- A minimum credit score of around 640
- A down payment of at least 3% (20% if you want to avoid paying mortgage insurance)
Since many conventional loans are sold to government entities like Fannie Mae and Freddie Mac, lenders often take little risk on individual loans, which means borrowers can often get the lowest interest rates available. , especially if they have good or excellent credit and household income over $ 60,000 to $ 75,000 per year.
A classic loan is ideal for:
- Those with stable full-time jobs that provide regular and consistent pay stubs
- Self-employed with three or more years of consistent and reliable income
- Married couples with moderate to high household income and little debt
Vs compliant. Non-compliant loan
A conventional loan falls into two different categories: compliant and non-compliant. Compliant loans are those who comply to the loan standards set by Fannie Mae and Freddie Mac, which means that Fannie or Freddie will buy the loan from the lender, so the lender doesn’t have to wait 30 years to collect the full loan amount.
The other type of conventional loan, non-conforming loans, do not meet the Fannie or Freddie loan standards, so they cannot be sold quickly by the lender. Since lenders have to hold on to these loans longer, they take on more risk, which means that the interest rates are generally higher, as are the minimum credit requirements. These loans are often reserved for particularly qualified borrowers who have high income and equity.
How Jumbo Mortgages Work
Jumbo mortgages are similar to conventional loans, with one difference – they have loan amounts above the conforming loan limit ($ 510,400 for most areas in 2020, but this varies by location).
Because these loans do not conform to the loan requirements of Fannie and Freddie, they cannot be sold as easily by the lenders. This means that lenders have to take more risk when giving jumbo loans, so they sometimes require higher down payments, higher minimum credit scores, or lower debt-to-income ratios to qualify.
What is the minimum down payment for a conventional mortgage?
The lowest advance payment available for conventional mortgages is 3% for 30 years fixed rate loans. For variable rate mortgages (ARM), the requirement is higher – 5%. However, any borrower who makes less than 20% down payment will need to purchase mortgage insurance.
The minimum down payments for conventional loans are:
- 3% for fixed rate loans
- 5% for adjustable rate loans
When to pay for private mortgage insurance
Any borrower with a classic credit who places less than 20% is required to buy private mortgage insurance (PMI), which increases the annual cost of the loan. This mortgage insurance can be canceled once the owner’s equity in their home exceeds 20%. Mortgage default insurance provides protection for your lender in the event of your loan default.
Conventional loans vs. Other types of mortgages
Conventional loans are similar to other types of home loans, especially government backed ones such as FHA and USDA loans. However, since conventional mortgages are issued by private lenders and may not be government insured, they generally require higher minimum credit scores to qualify.
The biggest difference between conventional mortgages and other government guaranteed home loans is that government guaranteed loans are generally designed to help low to moderate income borrowers or those with lower credit scores. Conventional loans, on the other hand, are ideal for those with good credit, stable jobs, and a low debt-to-income ratio.
Comparison of conventional loan rates
Although conventional mortgage rates are relatively low compared to alternative home loans, they are generally not as low as some government guaranteed mortgages.
Additionally, conventional mortgages can be more expensive than government guaranteed loans for borrowers who are unable to save 20% less because they need to purchase private mortgage insurance. This insurance typically adds 0.5% to 1% to the cost of the loan each year, which is more than the mortgage insurance required by the FHA and USDA home loan programs.
If you have a credit score of 700 or higher, a debt-to-income ratio of 35% or less, and a down payment of 20% on your loan, a conventional mortgage may be your best bet. If your credit score is below 640 or if you can’t save 20% less, you may want to consider an FHA or USDA loan instead.