Everything You Need To Know About The Most Popular Conventional Home Loan
Also known as conforming loans, conventional loans “conform” to a set of standards set by Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation), two agencies that help standardize mortgage lending in the U.S. two of the largest acquirers of mortgages on the secondary market. In fact, nearly 70% of all home loans made in the United States are conventional. Fannie and Freddie are government-sponsored entities (GSEs), not agencies, that are regulated but not operated by the U.S. Government.
In mortgage-speak, loans break down into two categories — conventional and government. A conventional mortgage is the industry phrase for a loan made by a private lender, such as a bank. Many conventional loans are subsequently sold to Fannie Mae or Freddie Mac, the quasi-governmental companies that exist to buy up great quantities of loans to keep money circulating through the loan system. The word “conventional” refers to a loan not insured by a government agency (unlike FHA, VA and USDA loans which are backed by government-operated insurance pools). Also, the size of conventional loans cannot exceed conforming loan limits set by the Federal Housing Finance Agency (FHFA).
Nearly 70% of all home loans made in the United States are conventional.
Conventional loans can be the most flexible loan products on the market. Their guideline rules can and often change yearly. The main change, year after year, is to the upper loan limits. Anything above that limit is known as a jumbo loan, which is usually a conventional, non-conforming loan. Fannie and Freddie do not sponsor jumbos. Instead, jumbo loans are sold to private investors or held by the banks that may have initially underwritten them.
Highlights of The Conventional Loan Program
Can use to buy a primary residence, second home, or rental property Available in fixed rates, adjustable rates (ARMs) with loan terms from 10 to 30 years Down payments as low as 3% No monthly private mortgage insurance (PMI) with a down payment of at least 20% Lower mortgage insurance costs than FHA loans Mortgage insurance is cancelable when home equity reaches 20% (unlike FHA which lasts the life of the loan)
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2019 Guidelines For Conventional Loans
2019 Conventional Loan Limits
The conventional loan limit for 2019 is $484,350 for a single family home. Though, Fannie Mae (FNMA) and Freddie Mac (FHLMC) have designated high-cost areas where limits are higher. For example, a single-family home in Seattle, WA could have a maximum loan of $592,250. The same home located in Los Angeles, California would be eligible for a loan amount up to $636,150.
Increased loan amounts are also available for 2, 3, and 4-unit homes. For multi-family homes located in high-cost areas, loan limits are even higher. For example, a 4-unit home in Honolulu, Hawaii can be financed up to $1.2 million.
Fannie Mae Guidelines
Standard conventional loan limits: 1-unit home: $484,350 2-unit home: $620,200 3-unit home: $749,650 4-unit home: $931,600
Types Of Conventional Loan Programs
Conventional loans fall into three categories: Conforming Loans Portfolio Loans Jumbo Loans
Conventional loans offer a dizzying variety of options. The 30-year fixed-rate loan is the default choice. If you prefer to pay off the mortgage more quickly, you can choose a 10-, 15- or a 20-year fixed-rate loan. Shorter-term fixed-rate loans offer lower interest rates but higher monthly payments. You can also get an adjustable-rate conventional loan, which starts at a lower rate for a fixed period of years before adjusting to prevailing market rates in the future.
Until recently, getting a conventional mortgage meant making a 20% down payment. That was not a very pleasant situation for first-time home buyers, who often had less cash saved up to buy a home. In the past, conventional loans were mostly used by “move up” buyers who could use the equity from their first home as the source of down payment money to buy a bigger home.
Several conventional loan programs that require less money down (e.g. 3% or 5%) and compete directly with traditional low down payment programs.
However, the world is different today; several conventional loan programs that require less money down (e.g. 3% or 5%) and compete directly with traditional low down payment programs like FHA. Whatʼs more, some conventional mortgages are specifically designed for low and moderate-income borrowers.
Conventional Purchase Loan
This is your straight-up, classic version of a home loan for borrowers with good credit and at least a 20% down payment. When the LTV is 80, no mortgage insurance is required. Pricing is very competitive, especially when you can skip the extra monthly add-on for those insurance premiums.
This Fannie Mae Conventional 97 program is for first-time homebuyers only. Thatʼs not as harsh as it sounds. It just means you canʼt have a current interest (ownership) in another property nor an interest within the last three (3) years. For example, if you sold a house five years ago and rented ever since, you’re an eligible first-time buyer. This program only requires 3% down.
Hereʼs another Fannie Mae program but for low to moderate-income borrowers; income limits apply. Furthermore, applicants will need to talk about a homeowner education course to become eligible. For HomeReady, borrowers only need a 3% down payment. And itʼs open to buyers who have owned a home within the last three (3) years.
Home Possible (+ Home Possible Advantage)
These two, similarly named programs, are Freddie Macʼs low down payment options. The down payment requirements are either 3% or 5%, depending on the number of units in the property (1 to 4). A one-unit property qualifies for the Home Possible Advantage loan and requires 3% down. Multi-unit properties qualify for the Home Possible mortgage program and require 5% down.
Applicants do not need to be first-time home buyers, but they do need to take an online or in-person homeownership course to qualify.
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If youʼre looking to cash out some built-up equity, take advantage of a lower interest rate or convert to a shorter-term mortgage (e.g. change from a 30- year to a 15-year loan), conventional refinance programs are available, too. The amount of cash you can extract varies by program.
Private mortgage insurance, or PMI, is required for any conventional loan with less than a 20% down payment.
PMI rates vary considerably based on credit score and down payment.
For instance, one PMI company is quoting the following rates, as of the time of this writing, for a $250,000 loan amount and 5% down. 740 credit score: $123 per month 660 credit score: $295 per month
And these are quotes for a 10% down payment:
740 credit score: $85 per month 660 credit score: $208 per month High PMI rates for lower credit scores prompt many buyers to use an FHA loan. Unlike conventional loans, FHA loans do not charge higher mortgage insurance rates, even for applicants with very low scores.
Another factor that might affect your PMI rate: the mortgage insurance company itself.
Many PMI companies exist, and your company is usually chosen by your lender. However, you do have some say in the choice. If you know a particular PMI company that offers the best deal, ask if your lender works with them.
If not, the lender may be able to provide a similar offer from a different PMI provider, or you can choose a lender that works with your chosen mortgage insurance company.
Qualifying – Requirements
Conventional loans may sometimes have a reputation of being more difficult to qualify for. Thatʼs simply not the case.
Elements of approval are the same as those for more “liberal” government-backed loans: you need to prove you earn enough income, that your income is expected to continue, you have enough assets to cover the down payment, plus you have an adequate credit history.
But it is true that lenders tend to set a higher bar for conventional loan applicants than for other applicants – FHA buyers, for instance.
Conventional loans do not come with an implicit government guarantee that repays the lender if the buyer fails to do so. That comes with a higher risk for and therefore higher standards from the lender.
Still, home buyers should not shy away and assume they canʼt qualify. In fact, conventional loan qualification is not difficult for the average home buyer.
Income and Assets
Like with most other loan types, youʼll be required to provide documentation proving your income and assets. Hereʼs a list of some of the documentation you may need:
60 days of bank statements (all pages) 30 days of pay stubs 2 years tax returns if self-employed, have rental properties, or non- salary income (retirement, pension, etc.) 2 years
W2s Social security, retirement and/or pension award letters, and 2 yearsʼ 1099s Rental agreements for any investment properties currently owned
Maintenance also termed alimony, can also be counted if documented in a divorce decree, along with the recurring method of payment such as an automatic deposit. Seasonal income is also accepted, again with proof in a tax return.
Debt-to-Income (DTI) Ratio
Underwriters will determine what you can afford based on the how much debt you carry compared to your income, called a debt-to-income (DTI) ratio. Two calculations comprise DTI. The first calculation called a front- end ratio, shows what percentage of your monthly income will be used to make your monthly mortgage payment.
Mortgage Payment / Gross Income = Front-End Ratio
The second calculation, called a back-end ratio, is very similar to the front- end ratio but it adds all your monthly debt obligations.
Mortgage and Debt Payments / Gross Income = Back-End Ratio
For conventional mortgages, underwriters place more emphasis on the back- end ratios.
Here are those ratios for some popular programs:
Conventional 97: 43% HomeReady: 45% Home Possible: 45% Home Possible Advantage: 43%
If you have dings on your credit or donʼt have a lot of cash reserves, your maximum DTI may be much lower than 45%. In general, the lower your DTI, the higher your chance of loan approval.
The best way to check the maximum home price for your debt-to-income level is to get a pre-approval from a conventional loan lender.
Conventional Loan Credit Scores
In general, conventional loans are best suited for those with a credit score of 680 or higher. Applicants with lower scores may still qualify, but the associated costs may be lower with other loan programs. For example, Fannie Mae and Freddie Mac impose Loan Level Price Adjustments (LLPA) to lenders who then pass those costs to the consumer. This fee costs more the lower your credit score.
For instance, someone with a 740 score putting 20% down on a home has 0.25% added to their loan fee. But, someone with a 660 score putting the same amount down would have a 2.75% fee added.
If you had the unfortunate experience of going through a bankruptcy or foreclosure, you could still get a conventional loan after a certain amount of time, known as a waiting period. With the passage of time, all wounds heal. Here are a few common derogatory credit events and their waiting periods:
Chapter 7 or Chapter 11: A four-year waiting period, measured from the discharge or dismissal date is required. A waiting period two years is possible if extenuating circumstances can be documented, such as job loss that is not expected to recur.
Chapter 13: Two years from the discharge date or four years from the dismissal date. With extenuating circumstances, a waiting period of two years is possible from the dismissal date.
Bankruptcy is never a good thing on your credit report, but it doesnʼt necessarily disqualify you from ever getting another mortgage.
The lender will likely insist that the house itself be a reasonable risk, documented by an appraisal that values the house at or above the selling price. If not, use the appraisal as a bargaining chip to get the seller to come down in price. The lenderʼs maximum loan amount is based on appraised value if it is lower than the purchase price.
Value isnʼt the only thing to watch for when getting a convention loan appraisal. Sometimes, during an inspection, the appraiser may require another professionalʼs opinion.
However, conventional loans actually come with less strict appraisal and property requirements than do FHA, VA or USDA loans. This is another advantage to conventional: you can qualify for a home in slightly worse condition and plan to make the repairs after your loan is approved and you move in.
All single-family, one-unit properties are eligible for any conventional loan program. From there, the kind of home you want to buy or refinance gets a little tricky. Each program has its guidelines for condos, manufactured homes, PUDS, and co-ops. Rather than bore you with the details, you may just want to ask a loan advisor about your particular situation and the kind of home you want to finance.