Understanding Conventional Mortgage Loan – Different Types for Your Home

Understanding Conventional Mortgage Loan – Different Types for Your Home

Understanding Conventional Mortgage Loan – Different Types for Your Home

Understanding Conventional Mortgage Loan –Different Types for Your Home.

There is a great deal of jargon and acronyms used in the mortgage industry, ranging from LTV ratios to DTI ratios. The phrase “conventional mortgage loan” is one that you will probably hear sooner or later.

Even though it seems unimportant, it is of the utmost significance. When it comes time to purchase your next home, there is a good chance that you will be required to submit an application for a conventional mortgage loan. This is the case even if you are a veteran, reside in a rural area, or have a low credit score.

Therefore, you should be aware of the ways in which conventional mortgages differ from other types of loans.

What exactly is meant by the term “conventional mortgage loan”?

A conventional loan is any mortgage loan not issued or guaranteed by the Federal Housing Administration (FHA), Department of Veterans’ Affairs (VA), or U.S. Department of Agriculture (USDA) (USDA).

The vast majority of conventional loans are guaranteed by either the Federal Home Loan Mortgage Corporation (FHLMC) or the Federal National Mortgage Association (Fannie Mae) (Freddie Mac). These government-sponsored enterprises provide a guarantee against default on the loans. As a result, the cost of the loans for borrowers is reduced because the risk for lenders is reduced.

In most cases, more creditworthy borrowers opt for private conventional loans rather than Federal Housing Administration (FHA) loans. The exception applies to qualified borrowers who, as a result of their prior military service or rural location, are eligible for subsidized loans from either the VA or the USDA.

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The Process of Obtaining a Conventional Mortgage Loan

In the case of a conventional loan, the application process typically entails making a phone call to a local bank or credit union in order to obtain a mortgage. The loan officer will begin by asking you some fundamental questions before presenting you with a few different loan programs that are tailored to your credit history, income, loan amount, and any additional borrowing needs you may have.

Both Fannie Mae and Freddie Mac are responsible for administering these loan programs. Underwriting standards vary depending on the type of business.

After deciding which type of loan best suits your needs, you will need to present the lender with a mountain of documentation. The loan officer will hand off your file to a loan processor, who will then send it on to an underwriter for review.

After making a significant number of new requests for information and documents, the underwriter finally gives their stamp of approval to the file and gives it the all-clear to close. At the closing, you will then have to spend hours signing a mountain of paperwork. You will emerge from this process with a brand-new house and a severe case of hand cramps.

But the fact that the quasi-governmental entities Fannie Mae and Freddie Mac back the loans does not necessarily mean that they issue the loans themselves. The majority of the time, conventional loans are issued by private lenders, who then sell those loans on the secondary market as soon as the loan closes. Therefore, even though you borrowed the money for your loan from a small community bank, it will immediately be transferred to a large financial institution such as Wells Fargo or Chase. They will be the ones receiving payments from you for the next fifteen to thirty years, not your local bank.

Because they lack the capital necessary to do so, most banks do not engage in the practice of keeping loans on their books for extended periods of time. They only want to collect the points and fees that they charge for originating loans, at which point they will sell the loans, buy new ones, and start the process over again.

Because of this, all lending institutions participate in the same loan programs offered by Fannie and Freddie. This allows the lending institutions to sell loans that are reliable and guaranteed on the secondary market.

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Conventional Loan Requirements

Conventional loans are available in a wide variety of loan programs, and each loan program has its own set of requirements to meet.

However, these requirements are evaluated using a standard set of standards that are the same across all loan programs. Before beginning your search for a mortgage loan, it is important that you have a solid understanding of the following concepts.

Credit Rating (Score)

Each type of financing comes with its own required minimum credit score. In order to qualify for a conventional loan, you will typically need to have a credit score that is at least 620. But even if your score is higher than the program’s minimum requirement, a lower score will result in increased scrutiny from underwriters, which increases the likelihood that they will decline your loan application.

Mortgage lenders typically look at a score that falls somewhere in the middle of the range provided by the three major credit bureaus. The higher your credit score is, the more different loan programs you are qualified for, as well as the better ones. This results in reduced requirements for loans, including interest rates, fees, and initial deposits.

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Therefore, while you are putting money away for a down payment and getting ready to apply for a mortgage, you should also work on improving your credit rating.

Payment in advance

You can qualify for a conventional loan with a down payment that is as little as three percent of the total price of the property if you have an excellent credit score. When purchasing a home, you should prepare yourself to make a down payment of at least 20 percent if you have poor credit, are purchasing a second home, or are investing in real estate.

When discussing loans and initial payments, lending professionals use the term loan-to-value ratios, abbreviated as LTV for short. That is the proportion of the property’s total value that the lending institution will let you borrow, expressed as a percentage.

Each type of financing comes with its own maximum loan-to-value ratio. For borrowers who meet the requirements, Fannie Mae’s HomeReady program, for instance, can provide an LTV of up to 97 percent. Your initial deposit accounts for the remaining 3 percent of the total.

Ratio of debt to annual income (DTI)

The amount of money you can borrow is also based on how much money you bring in each month.

Your debt-to-income ratio, which is the proportion of your earnings that goes toward paying off your mortgage and other debts, will determine the maximum amount of money a lender will let you borrow. To be more specific, they compute two distinct DTI ratios, one called the front-end ratio and the other the back-end ratio.

The only costs that are included in the front-end ratio are those that are related to housing. These costs include the principal and interest on your mortgage, property taxes, homeowners insurance, and, if applicable, fees for your condo or homeowners association. To determine the ratio, add up all of your housing costs and then divide that number by your total income before taxes and other deductions. The maximum front-end ratio that can be allowed with a conventional loan is typically 28 percent.

When calculating your back-end ratio, your housing expenses, along with all of your other debt obligations, are included in the calculation. This includes the payments you make on your car, student loans, the minimum payments on your credit cards, and any other monthly debts you have. Back-end ratios of up to 36 percent are typically acceptable for conventional loans.

For instance, if you have a monthly income of $5,000 before taxes, you can anticipate that your lender will set a ceiling on your monthly payment at $1,400, which will include all of your housing expenses. Your total monthly obligation, including this payment and all of your other debt payments, could not be more than $1,800.

The lender will then work backwards from that value to determine the maximum amount of money you are eligible to borrow, based on the interest rate that you are eligible for receiving on the loan.

Loan Limits

In the majority of the United States, “conforming” loans will allow up to $647,200 for single-family homes in the year 2022. On the other hand, Fannie Mae and Freddie Mac will finance loans of up to $970,800 in regions with a high cost of living.

Higher conforming loan limits are available for properties that contain two to four separate units:

Units Standard Limit Limit in High CoL Areas
1 $647,200 $970,800
2 $828,700 $1,243,050
3 $1,001,650 $1,502,475
4 $1,244,850 $1,867,275

You are still able to borrow conventional mortgages above those amounts, but they are considered “jumbo loans.” The difference between conforming loans and non-conforming loans will be discussed in more detail in the following paragraph.

Mortgage Protection (Private) Insurance (PMI)

If you borrow more than 80 percent of the value of the home, you will be required to pay an additional amount each month for mortgage insurance (PMI).

The lender is the one who is protected by private mortgage insurance—not you. This safeguards them against losses that may arise as a result of your failure to repay the loan. For instance, if you fail to keep up with your payments and the lender is forced to foreclose on the property, resulting in a loss to the lender of fifty thousand dollars, the lender will submit a claim for private mortgage insurance (PMI), and the insurance company will pay them to cover most or all of the loss.

The good news is that when you pay down your loan balance to below 80 percent of the value of your home, you are eligible to submit an application to have your PMI removed from your monthly payment.

Conventional Loans Come in a Variety of Forms

Although there are a great number of conventional loan programs available, most conventional loans can be placed into one of several broad categories.

Loans That Are Conforming

Conforming loans are loans that are acceptable for use within the loan programs offered by Fannie Mae or Freddie Mac and also fall within the loan limits of those two agencies, as outlined above.

There is no such thing as a non-conforming conventional loan. However, conventional loans also include jumbo loans, which are loans with a size that is greater than the size limits for conforming loans.

Loan That Does Not Conform

There are some conventional loans that do not “conform” to the requirements of Fannie or Freddie’s loan programs. Jumbo loans are the most typical example of a non-conforming loan that is still considered to be conventional.

In general, jumbo loans are accompanied by more stringent requirements, particularly those pertaining to credit scores. They will frequently do this in addition to charging higher interest rates. On the secondary market, however, lenders continue to buy and sell these assets.

Some banks do offer additional kinds of conventional loans; however, these loans do not comply with the criteria set forth by Fannie Mae and Freddie Mac. Instead of selling these loans, the vast majority of the time the company will keep them on their own books as portfolio loans.

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Because of this, rather than conforming to a standard loan program used across the country, these loans are individual to each bank. For homes that need some work, the bank might, for instance, provide its very own “renovation-perm” loan. This kind of loan enables a draw schedule during the initial phase of the renovation process, after which it transitions into a “permanent” mortgage with a longer repayment term.

Fixed-Rate Mortgage

Fixed-rate mortgages are loans that have interest rates that are locked in for the duration of the loan, as the name suggests.

Instead of changing at a predetermined rate over the course of the loan’s duration, the interest rate is fixed at the beginning. This means that your monthly payments will remain the same throughout the entirety of the loan term, regardless of any changes in the amount of property taxes or insurance premiums.

Adjustable-Rate Mortgages (ARMs)

You might consider getting a mortgage with an adjustable-rate as an alternative to getting a loan with a set interest rate. After an enticing initial period with a fixed low-interest rate, the interest rate will periodically adjust based on some benchmark rate, such as the rate at which the Fed funds rate is being offered.

When your mortgage interest rate adjusts for the worse, you make yourself an easy target for lenders who may contact you in the future with offers to refinance your loan. When you refinance your mortgage, you are responsible for paying another set of closing costs. In addition, because of the way that mortgage loans are structured, you will be responsible for paying a disproportionate amount of the total interest on your loan during the first few years after you have refinanced it.

The Benefits and Drawbacks of Conventional Home Loans

Conventional loans, like everything else in life, come with their fair share of benefits and drawbacks. They provide a wide variety of options and interest rates that are lower than average, amongst other positives, but they may be less flexible in some significant respects.

The Benefits of Conventional Loans for Homes

  • As you investigate the various possibilities for obtaining a mortgage loan, you should keep the following advantages of conventional loans in mind.
  • Very little interest. Among conventional loans, the best rates and terms are typically reserved for borrowers with excellent credit.
  • Removable PMI. As soon as the principal balance on your mortgage drops below 80 percent of the value of your home, you are eligible to submit an application to have PMI removed from your regular monthly payments. In point of fact, it vanishes without further action on your part once you have reached 78% of your home’s initial valuation.
  • There is No Borrowing Cap. Borrowers with higher incomes have the option of taking out loans in order to purchase expensive homes that are priced too high to qualify for government-backed mortgages.
  • There is no restriction on the use of second homes or investment properties. A conventional loan is one option for financing the acquisition of a second home or investment property. Loan programs offered by the FHA, VA, and USDA do not cover purchases of properties of this kind.
  • There are no fees specific to the program. Some loan programs that are backed by the government have associated fees, such as the up-front mortgage insurance premium fee that the FHA charges.
  • Additional Loan Options Loan programs that are backed by the government are typically more stringent. Conventional loans provide borrowers who are qualified and have high credit scores with a wide variety of options to choose from when it comes to loan programs.

Negative Aspects of Conventional Mortgages

  • Before you commit to a conventional loan for the next few decades, however, you should make sure you have a thorough understanding of the drawbacks associated with such loans.
  • Reduced leeway in terms of credit. Conventional mortgages are examples of the functioning of private markets and do not receive any direct support from the government. Because of this, they are an excellent option for borrowers who are eligible for loans based on their own merits, but they are not a viable choice for borrowers who have poor credit.
  • Reduced leeway in terms of DTI. In a similar vein, the maximum debt-to-income ratios for conventional loans are typically lower than those for government loan programs.
  • Reduced Leniency with Regards to Bankruptcies and Foreclosures Conventional lenders won’t provide loans to borrowers if they have filed for bankruptcy or gone through a foreclosure in the past X number of years. There is a possibility that government loan programs will make this possible sooner.

Conventional mortgages versus loans from the government

FHA loans, VA loans, and USDA loans are all examples of loans provided by various government agencies. These loans are all subsidized by the government through tax dollars, and their recipients fall into one of several categories.

In the event that you belong to one of these categories, you should think about applying for a government-backed loan rather than a conventional mortgage.

Comparison of a Conventional Loan to a VA Loan

You may be eligible for a subsidized VA loan if you have served in the armed forces, which is a perk of serving in the armed forces. If you are able to obtain a loan from the VA, it is typically in your best interest to do so.

In particular, Veterans Affairs (VA) loans come with the well-known option of making no down payment at all. They do not require private mortgage insurance (PMI), do not impose a prepayment penalty, and have relatively lax underwriting requirements. If you think you might be eligible for a VA loan, you should learn more about the benefits and drawbacks of these loans.

Comparing an FHA Loan to a Conventional Loan

FHA loans were designed by the Federal Housing Administration to assist Americans with lower credit scores and lower incomes in obtaining homeownership.

For borrowers with credit scores as low as 580, FHA loans come with a generous LTV of 96.5 percent. This is the most notable benefit of FHA loans. That amounts to a down payment of 3.5 percent. Even borrowers with credit scores ranging from 500 to 579 are eligible to put only 10% of the total loan amount down.

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Despite the fact that FHA loans are subsidized by taxpayers, they still have a few drawbacks. Even if you pay your loan balance down to below 80 percent of the value of your home, you won’t be able to get rid of the mortgage insurance premium that’s added onto your monthly payments because the underwriting process is so rigorous.

Before moving forward, give careful thought to both the benefits and drawbacks of FHA loans. However, be aware that if you are unable to qualify for conventional loans, you may not have any other borrowing options available to you.

Comparison of a Conventional Loan and a USDA Loan

The United States Department of Agriculture (USDA) offers loans to rural communities, as you might have guessed.

USDA loans, much like VA loans, offer the well-known option of making no down payment at all. They also provide a lot of wiggle room for credit scores that aren’t perfect, and borrowers with credit scores lower than 580 can sometimes qualify for one of these loans.

However, there are geographical limitations associated with them. USDA loans are only available in certain parts of the country, which are typically rural areas located further away from major cities. Learn more about USDA loans by doing some research on the topic.

Questions and Answers About Conventional Mortgage Loans

Mortgage loans are complicated, and getting your decision right could mean saving or losing tens of thousands, even hundreds of thousands, of dollars. The following is a list of the topics that are included in the most frequently asked questions regarding conventional loans.

Can You Tell Me the Interest Rates That Are Associated with Conventional Loans?

Rates of interest are subject to daily fluctuations because they are determined in part by benchmark interest rates such as the LIBOR and the Fed funds rate. Additionally, they may shift in response to shifts in market conditions.

Aside from the ups and downs of the market, your personal qualifications also have an effect on the interest rate that is quoted to you. If your credit score is 800, you will pay significantly less in interest than a borrower with a credit score of 650 who is otherwise comparable to you. Your ability to keep your job and the value of your assets both factor into the rate that you are quoted.

Last but not least, using negotiation skills can frequently help you obtain a lower interest rate. Shopping around, finding the best deals, and playing lenders off of one another are all good ways to ensure you get the best rate possible.

When Applying for a Conventional Loan, What Documents Are Required?

When applying for a conventional loan, you will need the following documents at the very least:

Identification. This includes any photo identification issued by the government, as well as possibly your Social Security card.

Documentation to Verify One’s Earnings This will typically entail two months’ worth of pay stubs and two years’ worth of tax returns for W2 employees. Borrowers who are self-employed are required to provide extensive documentation from their business as evidence of their income.

Validation of the Assets. This includes your bank statements, statements from your brokerage accounts, statements from your retirement accounts, documents proving ownership of the real estate, and any other documentation supporting your net worth.

Validation of the Debt Balances. There is a possibility that you will also be required to provide statements from additional creditors, such as credit card companies or lenders of student loans.

This is merely the beginning. You should anticipate that your underwriter will ask you for additional documentation before the transaction is finalized.

What Is the Minimum Credit Score Requirement for a Conventional Loan?

You should aim to have a credit score that is greater than 620 at the very least. Be prepared for a higher level of scrutiny, however, if your credit score is lower than 700 or if you have a history of insolvency or foreclosure on your credit report.

Before you apply for a mortgage loan, you should work to improve your credit score as much as possible.

What Is the Average Down Payment for a Conventional Loan?

The type of loan program you have will determine the amount of your down payment. As a result, the loan programs that are available to you are determined by your income, credit history, and various other factors such as the amount that you wish to borrow.

You should be prepared to make a deposit of at least 3 percent. It is more likely that you will be required to make a down payment of 10 to 20 percent, and possibly even more.

What Kinds of Residential and Commercial Real Estate Can Be Bought With a Conventional Loan?

Conventional loans can be used to finance properties that have up to four units, but not anymore. This encompasses not only people’s primary homes but also vacation homes and properties held for investment purposes.

When Obtaining a Conventional Loan, Is An Appraisal Necessary?

Yes, all conventional loans require an appraisal. The lender will order the appraisal report from an appraiser that they are familiar with and trust, and in most cases, you will be required to make payment for the appraisal in advance.

The Last Word

When you shop around for mortgages, the number of choices you have will be proportional to how high your credit score is.

If you are eligible for a VA loan or a USDA loan, the lending organization may provide you with a lower interest rate or lower fees. However, if you are able to qualify for conventional loans rather than FHA loans, you will most likely find a better deal among the latter. This is assuming, of course, that you are eligible for conventional loans.

When looking for the best mortgage, it is important to compare not only different interest rates but also different closing costs. Don’t be afraid to try to negotiate a better deal on both of them.


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