What is a Conventional Loan?
A conventional loan is a type of mortgage or home loan that is not insured or guaranteed by a government agency, such as the FHA loans, VA loans, or the USDA loans. Instead, conventional loans are offered by private lenders like banks, credit unions, and mortgage companies.
What are the Conventional Loan Requirements?
Conventional loans are subject to guidelines set by lending institutions and are typically based on your creditworthiness, income, employment history, and overall financial picture. Conventional loans usually require a higher credit score and a larger down payment compared to government-backed loans. The down payment requirement can vary but is often around 5% to 20% of the home’s purchase price.
Credit score: The credit score needed to qualify for a conventional loan can vary based on the lender and other factors. However, as a general guideline, a credit score of 620 or higher is often considered the minimum requirement for a conventional loan. Having a higher credit score, such as 700 or above, will generally improve your chances of qualifying for a conventional loan and may also lead to better interest rates and terms.
Debt-to-income (DTI) ratio: Most lenders prefer a DTI ratio of 43% or lower for conventional loans. A DTI ratio of 43% means that your total monthly debt payments should not exceed 43% of your gross monthly income.
Down payment: A down payment of 5% to 20% of the home’s purchase price is common for conventional loans. It’s important to note that while a 20% down payment is often considered ideal to avoid PMI, many lenders do offer conventional loans with lower down payment options. If your down payment is less than 20%, you will likely need to pay for PMI, which is an insurance that protects the lender in case you default on the loan.
What are the Benefits of Conventional Loans?
Conventional loans offer several benefits that can make them an attractive choice for homebuyers and borrowers. Here are some of the key benefits of conventional loans:
Flexible Loan Options: Conventional loans come in various terms, including fixed-rate and adjustable-rate options. This allows borrowers to choose a loan that best fits their financial goals and circumstances.
Higher Loan Limits: Conforming conventional loans have higher loan limits compared to government-backed loans like FHA or VA loans. This means you can potentially borrow more money to purchase a higher-priced home.
No Upfront Mortgage Insurance: Unlike FHA loans, conventional loans with a down payment of 20% or more typically don’t require private mortgage insurance (PMI). This can result in lower monthly payments.
Competitive Interest Rates: Conventional loans often come with competitive interest rates, especially for borrowers with strong credit scores. This can lead to lower overall borrowing costs.
No Funding Fee: Conventional loans don’t have the funding fees associated with VA loans or the upfront and ongoing mortgage insurance premiums of FHA loans, which can save you money over the life of the loan.
Flexible Property Types: Conventional loans can be used to finance a wide range of property types, including primary residences, second homes, and investment properties.
Fewer Property Restrictions: Conventional loans typically have fewer property condition requirements compared to FHA loans. This can make it easier to purchase a wider range of homes.
Streamlined Refinancing: If you already have a conventional loan, refinancing to a new conventional loan can be relatively straightforward and may offer the opportunity to secure a better interest rate.
Private Mortgage Insurance (PMI) Options: If your down payment is less than 20%, you’ll likely need to pay for PMI. However, conventional loans often offer more flexibility in terms of how PMI can be structured, allowing you to choose from various payment and coverage options.
Seller Contribution: Conventional loans generally allow for a higher percentage of the home’s purchase price to be covered by the seller’s contributions or other third-party sources.
Availability: Conventional loans are widely available through various lenders, banks, credit unions, and mortgage companies.
What are the Types of Conventional Loans?
There are several types of conventional loans available to borrowers, each designed to suit different financial situations and needs. Here are some common types of conventional loans:
- Fixed-Rate Conventional Loans: Fixed-rate conventional loans are the most traditional type of mortgage. With this type of loan, the interest rate remains constant for the entire term of the loan, whether it’s a 15-year, 20-year, or 30-year loan. This provides borrowers with predictable monthly payments throughout the life of the loan.
- Adjustable-Rate Conventional Loans (ARMs): Adjustable-rate conventional loans have interest rates that are initially lower than fixed rates, but they can change periodically after an initial fixed period. For example, a 5/1 ARM has a fixed rate for the first five years and then adjusts annually thereafter. ARMs can be beneficial if you plan to sell or refinance the property before the adjustable period begins.
- Conforming Conventional Loans: These are conventional loans that adhere to the loan limits set by government-sponsored entities like Fannie Mae and Freddie Mac. Conforming loans are often associated with more favorable interest rates and terms due to the backing of these entities.
- Non-Conforming Conventional Loans (Jumbo Loans): Non-conforming loans, also known as jumbo loans, exceed the loan limits set by Fannie Mae and Freddie Mac. They are used for purchasing higher-priced homes. Jumbo loans typically have stricter credit and income requirements due to the higher loan amounts.
- HomeReady and HomePossible Loans: These are specialized conventional loan programs designed to help low- to moderate-income borrowers and first-time homebuyers. They offer lower down payment requirements and more flexible eligibility criteria.
- Conventional 97 Loan: This is a specific type of conventional loan that allows borrowers to make a down payment as low as 3%. It’s a great option for buyers who want to put less money down while still avoiding the higher interest rates and mortgage insurance associated with low down payment FHA loans.
- Conventional Renovation Loans: These loans allow borrowers to finance the purchase of a home as well as the cost of renovations or repairs in a single loan. They can be a convenient option for buyers looking to purchase a fixer-upper.
- Second Home and Investment Property Loans: Conventional loans can also be used to finance second homes or investment properties. The eligibility criteria and down payment requirements may be slightly different for these types of properties.
How to Apply for a Conventional Loan?
Applying for a conventional loan involves several steps to ensure that you provide the necessary information and documentation to the lender. Here’s a general overview of the process:
Preparation and Research:
- Review your financial situation: Evaluate your credit score, debt-to-income ratio, and savings for the down payment and closing costs.
- Determine how much you can afford: Use online calculators to estimate your monthly mortgage payments based on different loan amounts and interest rates.
- Research lenders: Research and contact different lenders to learn about their interest rates, fees, and loan terms.
Gather Documentation:
- Proof of income: Gather recent pay stubs, tax returns, W-2 forms, and any additional income documentation.
- Proof of assets: Collect statements from bank accounts, retirement accounts, and other assets.
- Employment history: Provide a record of your employment history, including previous employers and job titles.
- Credit information: Be prepared to authorize the lender to check your credit report.
- Personal identification: Have a valid government-issued ID, such as a driver’s license or passport.
Loan Application:
- Complete the application: Fill out the lender’s loan application form, either in person or online. Provide accurate information about yourself, your income, and the property you wish to purchase.
- Specify loan details: Indicate the loan amount, desired loan term (e.g., 30 years), and any other relevant details.
Provide Documentation:
- Submit required documents: Provide the lender with the documentation you’ve gathered, such as proof of income, assets, and employment history.
Loan Processing:
- Verification: The lender will review your application and documentation. They may request additional information or clarification if needed.
- Appraisal: The lender will order an appraisal of the property to determine its value and ensure it meets lending standards.
- Underwriting: The underwriter assesses your application and documentation to determine if you meet the lender’s criteria for the loan.
Loan Approval:
- Conditional approval: If everything meets the lender’s requirements, you’ll receive a conditional approval indicating that you are approved pending the satisfaction of certain conditions.
Closing:
- Obtain homeowners insurance: You’ll need to secure homeowners insurance and provide proof of coverage.
- Closing disclosure: You’ll receive a Closing Disclosure detailing the final loan terms, closing costs, and other financial details.
Signing and Funding:
- Closing meeting: Attend the closing meeting to sign the necessary paperwork, including the mortgage note and other loan documents.
- Payment: Pay the down payment and any closing costs as required.
Move-in:
- After closing, you’ll become the owner of the property and can move in if you’re purchasing a home.
- It’s important to communicate openly with your lender throughout the process and to respond promptly to any requests for information or documentation. Each lender’s process may vary slightly, so be sure to follow their specific instructions and timelines. Working with a qualified mortgage professional can help guide you through the process and ensure a smooth loan application and approval process.
A conventional loan is the typical go-to option when considering a mortgage. While various mortgage choices exist, a conventional loan is favored for its potential to minimize expenses and its popularity among borrowers. Though obtaining a conventional loan might seem challenging due to its stricter criteria, meeting requirements is manageable. To qualify, it’s crucial to align credit, income, and assets. Remember that flexibility exists among lenders, but compensating for weaknesses in one aspect may be necessary. For instance, a lower credit score might necessitate a larger down payment and higher income. In essence, having an appropriate credit score, sufficient income, and the ability to make a down payment are key factors in securing a conventional loan.
