Loan Types
Conventional Loan
What is a Conventional Loan?
Also called a “conforming” loan, a conventional loan is a type of loan that meets the requirements for Fannie Mae or Freddie Mac
Fannie Mae and Freddie Mac allow banks to free up funds so they make more loans to qualified buyers.
Fannie Mae and Freddie Mac are government-sponsored enterprises.
The way a conventional loan works is this:
- The bank makes a loan to a home buyer.
- Fannie Mae or Freddie Mac purchases the mortgage from the lender.
- They sell the mortgage to investors.
Using this system the bank is able to make more loans and help get more people into homes.
Conventional loans are the most common type of residential loans.
Conventional Loan Requirements
Since conventional loans are ultimately bought by Fannie Mae, Freddie Mac, you’ll need to meet their requirements as well as the requirements of your individual lender.
Most potential home buyers don’t realize that these requirements are often within reach. You no longer need 20% down or perfect credit to get a conventional mortgage.
Borrowers can often qualify for a conventional loan with:
- A credit score of 620 or higher
- Proof of a steady income and two years of employment.
- A downpayment of at least 3%.
Let’s look at each one of these requirements.
Credit Score
Generally, to get approved for a conventional loan, you need a credit score of 620 or higher.
When you apply for a loan, a credit check is run to check your credit score and credit report. Credit history is also taken into consideration to determine your eligibility. Higher scores tend to get better rates.
Issues that can affect your credit:
- Credit card debt.
- Outstanding loans.
- Late or missed payments.
- Bankruptcy or foreclosure.
Credit issues don’t necessarily mean you won’t qualify, however. As a mortgage broker, it’s possible to work together and repair your credit to a level to where you qualify.
Income & Employment
A lender usually wants to see two years of consistent income within the same field or with the same employer in order to issue approval. This must be proved through documentation such as W-2s, tax returns, bank statements, and pay stubs.
If you’re self-employed you may need to submit two years of business tax returns as well as personal tax returns.
Downpayment
The standard for conventional loans is that you are required to put at least 5% down.
However, if you are a first-time home buyer, it’s possible to get a conventional loan with only 3% down. To do so you will need to enroll in a program such as Fannie Mae’s HomeReady or Freddie Mac’s Home Possible. Generally, though, with a conventional loan, the downpayment requirement is 5%.
For conventional loans on second homes or a multi-family home, your downpayment require will be higher.
Other Conventional Loan Requirements
Loan Limits
It’s now possible to get a conventional loan for up to $726,200 in most states. In Hawaii the limit is $1,089,300.
If you need a loan for an amount higher than the limit, the loan then becomes what’s called “non-conforming”.
Non-conforming loans, or Jumbo Loans, allow you to obtain a bigger loan, but they also may come with more restrictions or a higher rate. This all depends on the individual lender.
Debt to Income Ratio
The debt to income ratio is the percentage of your gross monthly income that will go towards your future mortgage payment. For most conventional loans your DTI must be 50% or lower.
It’s easy to to calculate your DTI. Add up the minimum monthly payments on all your outstanding debts and divide it by your gross monthly income.
Property Requirements
There are property requirements for conventional loans.
- It must either be a single family home or, if it’s a multi unit property, there can’t be more than 4 units.
- It must have clear title. There can’t be any liens against the property.
- It can’t be a commercial property.
In addition, you’re going to need an appraisal. Lenders won’t lend you more than the home is worth. If the agreed upon purchase price exceeds what the home appraises for, you’ll be required to make up the difference.
Private Mortgage Insurance (PMI)
If you put down less than 20% down on a conventional loan, you will be required to get private mortgage insurance. This is to protect the lender in the event that you default.
There are several ways to pay for PMI:
- Add it on to your monthly mortgage payment. (the most common option)
- Pay it as an upfront fee along with closing costs.
- Take a slightly higher interest rate.
You can explore the best option for you when working with your broker to structure your loan.
Once you reach 20% equity in your home, either through monthly payments or appreciation, PMI is removed. With appreciation you’ll have to get a new appraisal and put in a request to the lender.
Is a Conventional Loan Right for You?
If you are a first-time home buyer, wish to put less down on a property, or just have good credit and employment history, a conventional or conforming loan may be the easiest option. It also may provide you with the best rate.
If you’re thinking about buying a new home, it’s never too early to apply for a loan and get prequalified.
And here’s a little more incentive:
For a limited time if you finance a loan with me, I’ll give you $5oo off the appraisal.
Give me a call at (415) 302-6416.
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