Conventional loan is one of the types of mortgages that exist in the world of mortgage. Conventional loans also have some requirements and guidelines which have to be followed if the borrower wants their application to be approved.

What are conventional loans?

Conventional loans or conventional mortgages are the type of mortgages which are not backed by any government entity. These mortgages are offered through private lenders such as mortgage companies, credit unions and banks. However, there are some types of conventional mortgages which are backed by government entities like Fannie Mae and Freddie Mac.

As compared to government backed loans, conventional mortgages are more mainstream and common. Although conventional loans are not backed by the government which makes them risky, they offer much more flexibility to the borrowers. This also means that it is tougher to qualify for conventional loans.

Usually, conventional loan mortgages have fixed interest rates which means that the rate of interest on this loan does not change throughout the lifetime of the loan. These loans are not guaranteed by the government which makes them risky. As a result of this, conventional loans have stringent requirements.

Conventional Loan Requirements

The requirements for conventional loans might vary from lender to lender. However, all conventional loans have some types of guidelines which are set by Fannie Mae and Freddie Mac. The requirements set by Fannie Mae and Freddie Mac are as follows:

  1. The minimum credit score requirement is 620
  2. The down payment of the conventional loan is as low as 3%
  3. The debt-to-income ratio should be lesser than 43%

The amount of conventional loans has to be in line with the conforming loan limits. In the majority of the areas, the conforming loan limit is $548,250 and higher in some of the expensive areas like California.

In order to avail lower interest rates and lower monthly payments, you should present a higher credit score and make a higher down payment. For example, a borrower who has a credit score 740 and makes 20% down payment can avail lower monthly payments and interest rates. There are some lenders who set their own requirements for conventional loans and they are allowed to do so as long as they fall within the conforming loan limits set by Fannie Mae and Freddie Mac.

>>More: Conventional loan requirements

Minimum down payment for conventional loans

There is a very common misconception among people that they need 20% down payment. This is not true because borrowers can get a loan with a down payment as low as 3%. There are 6 major types of mortgage options for the down payment of conventional loans which ranges from 3% to 20%.

The following are the types of loans:

  1. Conventional 97 loan – this loan requires a 3% down payment
  2. Fannie Mae HomeReady Loan – this loan requires a 3% down payment
  3. Freddie Mac Home Possible Loan – this loan requires a 3% down payment
  4. Conventional Loan with PMI – this loan requires a 5% down payment
  5. Piggyback loan (no PMI) – 10% down payment
  6. Conventional loan without PMI – this loan requires a 20% down payment

Ranging from conventional 97 loan with 3% down payment requirement to conventional loan without PMI with 20% down payment requirement, these options are very popular with the conventional loan buyers.

Let’s now talk about the myth of 20% down payment. When borrowers normally pay a down payment less than 20%, they also have to pay Private Mortgage Insurance (PMI). The Private Mortgage Insurance (PMI) protects the lender in the case if the borrower defaults. With private mortgage insurance (PMI), your monthly payments increase. However, for some buyers it is okay as long as they are able to get a loan with a down payment they can afford. Moreover, your PMI can be cancelled once you have a 20% portion of equity in your house.

Conventional Loan Rates

Conventional loan rates are usually low as they make housing affordable for everyone. For a 30-year fixed rate mortgage, the rate for conventional loans is 3%. The average rate drops to 2.5% for the 15-year conventional loans.

As of May 4th, 2021, the conventional loan rates are below:

Loan typeAverage Interest RateAPR
Conventional 30-Year FRM3%3%
Conventional 15-Year FRM2.5%2.5%
Conventional 5/1 ARM3%2.743%

The applicant’s credit score plays a very major role in the conventional loan rates. For example, the borrower with a credit score of 740 and a 20% down payment will get a conventional loan rate 0.5% lesser than the applicant who has a credit score of 640.

Advantages of Conventional Home Loans

Conventional loans are classified as one of the most important types of mortgages. After conventional loans, government backed mortgages like FHA, VA, and USDA loans are popular among loan buyers. There are many advantages of conventional home loans. Firstly, conventional loans offer flexible repayment plans to the borrowers. These loans come with a 15, 20, 25 and 30-year term. There are some lenders who even offer conventional loans with 10-year repayment plan. The shorter the term of your loan is, the higher the monthly payment. However, the most popular among the buyers is the 30-year fixed rate mortgage which comes with low fixed interest payments and this repayment plan is available to majority of the home buyers and refinancers. Secondly, conventional home loans offer adjustable rates to borrowers as well. This option comes with a lower rate of interest as compared to fixed-rate loans. Moreover, you do not have to pay an upfront mortgage insurance fee even if the buyers pay less than 20% down payment.

Qualifying for a Conventional Loans

For conventional loans, the minimum credit score requirement is 620. People who have acquired conventional loans have had an average credit score of 720. During the process of conventional loans, the lender may also require documentation related to your employment and income. The documentation may include 30 day’s pay stubs, W2 for 2 years, and if you are self-employed you are required to show 2-year tax returns.

The lender may not approve your loan if the amount of loan borrowed is greater than the value of the property. The debt-to-income ratio of the borrowers must be 43% or less. Other than this, conventional loan also has closing costs which includes costs such as lender’s origination fee, vendor’s fee and title insurance etc.

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