Conventional Loans
In this guide, we will cover conventional loans and the eligibility requirements. Conventional loans are the most popular mortgage loan program in the nation. Besides FHA loans, there is no other mortgage loan program more popular and common than conventional loans.
A conventional loan is any mortgage loan that is not insured or guaranteed by the government (such as under the Federal Housing Administration, Department of Veterans Affairs, or Department of Agriculture loan programs). Fannie Mae and Freddie Mac sets the standards on conventional loans. All conventional loans are referred to as conforming loans because they need to conform to Fannie Mae or Freddie Mac agency guidelines.
In the following paragraphs, we will discuss one of the most popular loan products used for purchasing a home. Homebuyers frequently use conventional loans, especially those with good credit profiles and large down payments. I will touch base on both of those criteria later in my blog.
What Are Conventional Loans?
When home buyers meet with lenders, it is likely that FHA, VA, USDA, and Conventional loans are discussed. Conventional loans differ from the others because a government agency does not secure them. Banks, credit unions, private lenders, and mortgage companies offer conventional loans. Be careful not to confuse the terms secured and guaranteed.
An FHA loan has less-restrictive qualifications compared to a conventional loan, which is not backed by a government agency. You need to have a higher credit score, lower debt-to-income (DTI) ratio and higher down payment to qualify for a conventional loan.
Conventional loans must conform to either Fannie Mae or Freddie Mac agency guidelines. Fannie Mae and Freddie Mac are government-sponsored entities as long as they fall within conforming loan requirements. When choosing the loan product that best fits your needs, it is important to remember that conventional loans generally have stricter credit guidelines than options such as FHA, VA, and USDA loans.
Fannie Mae and Freddie Mac Conforming Loan Limit on Conventional Loans
The loan limit is one factor determining whether or not the conventional loans will fall within conforming requirements, which is non-negotiable. The loan limit increased in 2022 to $647,200 from $548,250 in 2021. It has already been announced that the limit will again increase in 2023 to $715,000. The FHFA, or the Federal Housing Finance Agency, sets the loan limits.
So, what exactly are these limits? The baseline conforming loan limit for 2023 is $715,000 – up from $647,200 in 2022. The limit is higher in Alaska and Hawaii, which is $1,073,000 for a 1-unit property. Later this year, limits will be set for higher-cost counties as well.
If the loan amount fails to fall within the set limit, it is considered a Jumbo loan. Although the loan is still considered a conventional mortgage, it is not conforming. That means it is not eligible to be backed by either Fannie Mae or Freddie Mac.
Fannie Mae and Freddie Mac Guidelines on Conventional Loans
In the above section, we already mentioned the limits of a conforming conventional loan. A conventional mortgage down payment can vary. If you are considered a first-time homebuyer, you can put up as little as 3% on a conventional loan. The minimum down payment for those who are not first-time home buyers and for those who make more than 80% of the median income of the local area is 5%.
Most lenders offer conventional loans with PMI for down payments ranging from 5 percent to 19 percent. Mortgage lenders offer conventional loans with 3 percent down payment for first time homebuyers. A first time homebuyer is defined as a homebuyer who did not have ownership on a home in the past three years.. A Federal Housing Administration (FHA) loan.
What Is Borrower-Paid Versus Lender-Paid Mortgage Insurance?
Borrower-paid mortgage insurance is a temporary expense you can eliminate once you have at least 20 percent equity in your home. Lender-paid insurance saves you money up front but results in a higher mortgage interest rate that may cost you more over the life of the loan as it cannot be canceled.
Down Payment Requirement on Multi-Family Homes on Conventional Loans
The down payment minimum requirement goes up when you purchase a multi-family home or a property with more than one unit. The minimum for these types of properties is 15% on owner-occupant multi-family homes for conventional loans. There are other factors that will change the minimum down payment requirements as well.
In most cases, the minimum amount for a single-family home investment property down payment is 15% on conventional loans. However, the down payment you’re required to pay is determined by several factors, including your credit score, debt-to-income (DTI) ratio, loan program, and property type. Two-to-four unit multi-family investment property homes require a 25% down payment.
If the home is not your primary residence, the down payment on two-to-four-unit multi-level properties is a 25 percent down payment. What we are noticing more frequently now because interest rates are so high is an Adjustable Rate Mortgage (Arm).
Why Would I Put More Than The Minimum Down Payment Required on Conventional Loans?
The simple answer to this question is the less you borrow, the lower the payment. However, some of our clients don’t know before their buyers’ consultation that Private Mortgage Insurance is required on a conventional loan if you borrow more than 80% LTV. Private Mortgage Insurance (PMI) protects investors if there is a default on loan.
The minimum down payment required for a conventional mortgage is 3%, but borrowers with lower credit scores or higher debt-to-income ratios may be required to put down more. You’ll also likely need a larger down payment for a jumbo loan or a loan for a second home or investment property.
The two factors that determine the cost of your PMI are credit score and the amount of money as a down payment. If you borrow 90% LTV, you can request the PMI be canceled when you pay the balance down to 80%. Once the LTV reaches 78%, the PMI will automatically be removed from the loan.
Fannie Mae and Freddie Mac Credit Score Guidelines on Conventional Loans
A borrower’s credit score is one of the main determining factors for qualifying for a mortgage. When applying for a conventional mortgage, the minimum credit score is 620. You will find a lower minimum credit score when applying for mortgages such as FHA, VA, and USDA. Generally, a conventional mortgage will come with a lower interest rate than government-backed loans.
Fannie Mae and Freddie Mac set credit score requirements on conventional loans. In most cases, borrowers will need at least 620 FICO credit scores to qualify for a conventional loan.
Any score of 740 or higher will be treated as the best possible tier and, as a result, will come with the lowest interest rate available. Along with credit score, a borrower’s debt-to-income ratio is another determining factor for mortgage eligibility.
Fannie Mae and Freddie Mac Guidelines on Debt-To-Income Ratio on Conventional Loans
Debt to income is a percentage based on your monthly bills compared to the amount you bring in monthly. You simply take all your minimum monthly debt payments and add them up (any debts on your credit report, utilities are not included), then divide that number by your monthly income before taxes. Income before taxes is known as Gross monthly income.
Borrowers generally need a DTI of 45% or less to qualify for conventional loans. Under certain circumstances, you may be able to qualify with a DTI as high as 50% for borrowers with higher credit scores.
The maximum debt-to-income ratio to qualify for conventional loans is 50% DTI. In conclusion, we have shown that a conventional mortgage can be the least expensive cost to the borrower as long as you meet the eligibility requirements. As always, the best way to determine which mortgage option is best for you is by scheduling a buyers consultation with the staff at Non-QM Mortgage Brokers