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What is a Conventional Loan?
The most common type of mortgage is considered a conventional loan. Conventional loans can be used to Purchase or Refinance real property.
Conventional Loan Overview:
Even though conventional loans are not insured or guaranteed by the government, Conventional loans must still follow guidelines the set by Fannie Mae and Freddie Mac, two large publicly traded corporations (agencies) formed by Congress to purchase the loans that lenders make.
So, what’s the best loan for you? Government-guaranteed or conventional? Because conventional loans generally have fewer restrictions than government-guaranteed loans, lenders may have more discretion to offer their borrowers more flexible terms, features … and benefits.
- Down payments as low as 3%
- Fewer restrictions compared with government-back loans, such as no military affiliation (VA) or rural area (USDA) required
- No upfront mortgage insurance required
- Private Mortgage Insurance (PMI) can be canceled after 20 percent equity is achieved
- Higher credit scores can result in a lower interest rate
- Less strict appraisal and property requirements than FHA, VA or USDA loans
- Good credit, typically 620 or greater FICO.
- Provide a down payment, ideally 20% to avoid Private Mortgage Insurance (PMI).
- Show proof of income and two years of tax returns.
- Cash reserves on hand to cover closing and additional costs.
- Ensure total debt does not exceed 43% of your income, in most cases.
- Nationwide conventional loan limits of $453,100; up to $679,650 in higher-cost regions
Many consumers mistakenly believe that these loans require a 20 percent down payment. Although doing so would eliminate the need for Private Mortgage Insurance (PMI), the borrower who makes a smaller down payment can cancel PMI once the mortgage balance is paid down to 80% of the home’s original praised value. When the balance falls below 78%, the mortgage servicer is required to eliminate PMI.
For buyers with a stronger credit profile, they will typically find conventional loans a more economical choice than a government-backed loan. And, of course, if they come in with a down payment of 20% or more, they don’t pay any mortgage insurance, unlike FHA borrowers.
Don’t forget to ask about our I CAN mortgage, so you can customize the terms of your loan.
Difference Between Conventional and Government-Backed Loans
Government-backed loans include options like VA loans—which are available to United States Veterans—and Federal Housing Administration (FHA) loans. FHA loans are backed by the Federal Housing Administration, and VA loans are guaranteed by the Veterans Administration.
With an FHA loan, you’re required to put at least 3.5% down and pay MIP (mortgage insurance premium) as part of your monthly mortgage payment. The FHA uses money made from MIP to pay lenders if you default on your loan.
To qualify for a VA loan, you must be a previous or current member of the U.S. Armed Forces or National Guard—or have an eligible surviving spouse. A VA loan requires no down payment, but you must pay a one-time funding fee, which usually ranges from 1%–3% of the loan amount.
With a conventional loan, the lender is at risk if you default. If you can no longer make payments, the lender will try to recoup as much of the remaining balance as they can by selling your house through a short sale process or even foreclosure.
Because of this additional risk to the lender, you’re required to pay private mortgage insurance (PMI) on a conventional loan if you put less than 20% down.
Different Types of Conventional Loans
Conforming Conventional Loan
In order to be considered a conforming conventional loan, the loan must meet the guidelines set by Fannie Mae and Freddie Mac. No, those aren’t your friendly neighborhood grandparents. Fannie Mae (short for the Federal National Mortgage Association) and Freddie Mac (short for the Federal Home Loan Mortgage Corporation) are government-sponsored enterprises that purchase mortgages from lenders.
One of Fannie Mae and Freddie Mac’s most important ground rules is loan limit. For 2018, the baseline loan limit for one-unit properties is $453,100. It’s called baseline because the maximum amount—or limit—you can borrow is adjusted every year to match housing-price changes. In certain high-cost areas, the loan limit may increase to a maximum of $679,650.
Check with your lender to see what the conforming loan limits are for your area.
Nonconforming Conventional Loan
What about conventional loans that exceed the loan limit? These are considered non-conforming conventional loans.
Simply put, a non-conforming conventional loan (also referred to as a jumbo loan) is a conventional loan not purchased by Fannie Mae or Freddie Mac because it doesn’t meet the loan amount requirements. Instead, non-conforming loans are funded by lenders or private institutions.
How Do You Qualify for a Conventional Loan?
Your first step in qualifying for a conventional loan is to sit down with a lender. If you’re in the home-buying process, give us a call (800) 247-6663.
When you meet with a lender, they’ll ask for documentation like recent pay stubs, tax returns, bank statements, and other financial information. They want to make sure you have a steady income and can make your monthly mortgage payments on time.
You will also need a down payment to qualify for a conventional loan. Though you can put as little as 3% down when you get a conventional loan, we recommend putting at least 10% down. But 20% is even better because then you can avoid paying PMI!
If you want to start your home search on strong financial footing, talk to your lender about becoming a certified home buyer. Doing this will require a few extra steps up front, but it can give you an edge over other buyers in a hot market and get you to the closing table faster.