What is a conventional loan?

When it comes to thinking about the most common type of mortgage program or the most traditional, a Conventional loan is the closest that comes to that idea.

These are conforming loans that meet the guidelines set by the Federal Housing Finance Agency and are purchased by Government Sponsored Entities, the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal National Mortgage Association (Fannie Mae).

Conventional loans do not have any special eligibility requirements and don’t cater to any one group. Anyone that meets the required credit score and down payment requirements can qualify for conventional loans and that is exactly what makes these loan types one of the most widely accessible mortgages in the market.

 

Conventional loan requirements

The guidelines for conventional loans are set by the GSE Fannie Mae and Freddie Mac and lenders go on to create their own requirements as long as they remain within the GSE guidelines. This allows conventional loans to be very varied and allows borrowers to shop around and find an offer that meets their specific financial needs. It is possible to get approved for a conventional loan for lower rates by having a high credit score and paying 20% in down payment. Or if you meet just the basic requirements then shop around to find better offers.

Conventional loan requirements while varying have a minimum they have to meet:
– A credit score of at least 620
– A Debt to Income ratio of lower than 43%
– A Down payment of at least 3%

The conventional loan limit announced for the year 2021 is $548,250 in most areas of the country and can be higher for more expensive real estate markets.

>>More: Pros and Cons of a Cash-out refinance

Minimum down payment for a conventional loan

There is a persistent myth about conventional loans that they all require a down payment of 20%. While it is true that a 20% down payment is an option available through conventional loans this is not necessarily a bad thing. Mortgages that require less than 20% also usually require you to take out Private Mortgage Insurance, which adds additional payments. But these additional payments are worth it if they allow you to take out a mortgage that you can afford.

Conventional loans are available with different down payment options that start from as low as 3% and go up to 20%. These conventional loans are:
– Conventional 97 loan (3% Down payment)
– Fannie Mae HomeReady loan (3% Down payment)
– Freddie Mac Home Possible loan (3% Down payment)
– Conventional loan with PMI (5% Down payment)
– Piggyback loan without PMI (10% Down payment)
– Conventional loan without PMI (20% Down payment)

Conventional loan rates

Conventional loan rates are influenced by 3 main factors:

– Your credit score:

The interest rate on the mortgage plan increases the lower your credit score is and goes lower the higher your credit score is. Since the payments are calculated in a percentage and payments are on a monthly basis, even the difference of 0.5% can mean a lot over the course of a mortgage period spanning decades.

– Changes in the market:

Like all markets, the changes in the economy and real estate affect the rates of mortgage plans. In the last few decades the rates have been steadily going down and this is great news for people looking to become first time homeowners. But even small changes in today’s market affect the pricing of mortgages, it is important to always keep a check and take the opportunity when it reveals itself.

– Lender pricing:

Since conventional mortgages are the most popular type and used by 69% of borrowers, it is only understandable for lenders to be competitive about their pricing. This is an opportunity for borrowers to shop around to get an idea about the best available rates and also bargain to get rates that match their requirements.

Benefits of a conventional home loan

Flexible repayment plans

The best benefit of conventional loans is the flexibility and customizability. Depending on the needs of the borrower the interest rate, loan period, down payment, etc. can all be adjusted to come up with a unique plan that meets requirements. However, adjusting these details also changes how much payment you will be making on a monthly basis and over the full course of the loan.

Conventional loans are available in terms of 15,10,20,25 and 30 years. The shorter the period the more money has to be paid to cover the total loan amount. This is a tradeoff between how long you are in debt for the mortgage vs how much you can pay on a monthly basis to complete the repayment.

Adjustable rates

Conventional loans are available with two types of interest rates. Fixed rates and Adjustable rates. In a fixed rate mortgage plan the interest rate remains constant throughout the mortgage term and is suited for those who plan to stay in the property long term.

Adjustable rate mortgages are plans where the interest rate changes after a certain period of time, these plans are popular for those that plan to stay in the property for a certain period and then sell it.

No restrictive requirements

Conventional loans are meant to cater to people of all walks of life and are designed accordingly. They are the least selective of groups of people. Conventional loans are usually compared with government programs in terms of popularity and requirement difference but the fact is, government programs are meant for a very select few belonging to certain groups. Conventional loans by comparison have no such bias and are available to any that meet the requirements of Freddie Mac and Fannie Mae.

How do you qualify for a conventional loan?

Credit Score:

The average credit score for those that qualify for conventional loans is 720 but the minimum credit score required for a conventional loan is just 620. This score is manageable if you are good with your finances or have not experienced any serious financial problems.

Employment and Income:

Like all loans, conventional mortgages require borrowers to produce proof of income and employment. This will include documentation like 30 days of pay stubs, 2 years of W2 forms, 2 years of tax returns (if self-employed), contact number of the employer for verification, etc.

Private Mortgage Insurance:

PMI is required for any mortgage where the down payment is less than 20%. But the rates for the PMI can also vary depending on the credit score and down payment, the general rule is that the higher your credit score, the less you pay for PMI.

Debt to Income ratio:

The DTI for conventional loans should ideally be 36% or less but lenders may be accepting of DTI as high as 43%. Since it is the ratio of income to debt, it is possible to find out your DTI before applying for a loan and paying off any standing debts to improve the DTI score.

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