Conventional MortgagesFannie and Freddie
The conventional conforming loan is the traditional mortgage program. It is called “conforming” because it fits within the standardized guidelines set by Fannie Mae and Freddie Mac. It can be used to finance all different types of residential properties. The loan requires mortgage insurance if the down payment is less than 20 percent. The monthly mortgage insurance required for this loan is cheaper than FHA mortgage insurance. A conventional loan caters to those who have more money to put down & great credit scores.
- As low as 3% down on a primary residence purchase
- Debt-to-income ratio as high as 45%
- Qualifying guidelines more strict than FHA
- Requires monthly mortgage insurance (MI) if down payment is less than 20%
- MI can be cancelled at 80% loan-to-value
- Loan amount up to $417,000 (anything higher is a jumbo loan)
How Do You Qualify For A Conventional Loan?
Conventional loans have a reputation of being too hard to qualify for.
That’s not the case.
Elements of approval are the same as those for “easy” government-backed loans: you need to prove you make enough money, that your income is expected to continue, you have enough assets to cover the downpayment, plus you have adequate credit history.
But it is true that lenders 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 higher risk for — and therefore higher standards from — the lender.
Still, home buyers shouldn’t be scared away and assume they can’t qualify. Conventional loan qualification is not difficult for the average home buyer.
According to loan software company Ellie Mae, the average credit score for all applicants who successfully complete a mortgage is around 720. This is plenty high to get approved for a conventional loan.
The minimum accepted score for most conventional loans is 620. “We want to know that people pay their bills on time and are financially disciplined and good at money management,” says Staci Titsworth, regional vice president sales manager with PNC Mortgage in Pittsburgh, Pa. A slightly higher score may pass the credit-score test, but necessitate a higher interest rate to compensate for the greater risk.
Applicants with lower credit may want to choose an FHA loan, which does not charge extra fees or higher rates for low credit scores.
Above and beyond credit, approvals will be issued to applicants who can provide proof of earnings which may involve some or all of the following documentation.
- 30 day’s pay stubs
- 2 year’s W2s
- 2 year’s tax returns if self-employed
- An offer letter, if not yet started
- Proof of education for new graduates
“Most lenders require a two-year documentation to show a consistent earnings stream,” Titsworth says. Maintenance, also termed alimony, can also be counted if documented in a divorce decree, along with the recurring method of payment such as automatic deposit. Seasonal income is also accepted, again with proof in a tax return.
The lender will likely insist that the house itself be a worthy risk, documented by an appraisal that values the house at the selling price. If not, use the appraisal as a bargaining chip to get the seller to come down in price. The lender’s maximum loan amount is based on appraised value if it is lower than the purchase price. This could leave the buyer to come up with extra cash, or choose another property.
For instance, a home is offered at $200,000. But it appraises for $190,000.
The applicant must come up with his downpayment plus an extra $10,000 to cover the shortfall. Or the seller can come down in price.
Value isn’t the only thing to watch for when getting a convention loan appraisal. Sometimes, during an inspection the appraiser may require another professional’s opinion. “If the appraiser sees water stains or a lot of leaky faucets, he may request a plumbing inspection. The seller may need to make improvements, which could delay a closing,” Titsworth says.
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.
Low Down Payment Conventional Options
The amount of the borrower’s down payment can affect the interest rate and final loan costs.
Putting down a larger amount means that the monthly mortgage costs will be less. A payment of at least 20 percent will eliminate mortgage insurance, a requirement of the FHA and USDA loans even with a large downpayment.
Many conventional loans are made with as little as 3 percent down.
The HomeReadyTM mortgage program is one such option. It allows non-borrowing members of the household help the actual loan applicant become approved. Lenders will consider the income of mothers, fathers, extended family, and even that of non-married household members, even when they are not officially on the loan file.
The Conventional 97, as the name suggests, allows home buyers to borrow ninety-seven percent of the home’s price. Unlike the HomeReadyTM option, these loans are available to applicants at any income level buying a home in any location.
The drawback to a 3% down loan is that the interest rate may be higher to compensate for the smaller amount down. Mortgage insurance may be more expensive as well, as compared to a five- or ten-percent down conventional loan.
The piggyback 80/10/10 loan option lets the applicant skip the full 20% downpayment and mortgage insurance.
The applicant applies for a first mortgage for eighty percent of the purchase price. Simultaneously, he or she opens a second mortgage, such as a home equity line of credit (HELOC) for 10% of the purchase price. Then, only ten percent down is required.
The lender allows the borrowed ten percent loan to “count” toward the applicant’s downpayment. The amount down, then, is considered twenty percent in this case, removing the need for mortgage insurance altogether.
A conventional loan borrower has the option to put anywhere from three to 20 percent down or more. Plus, a downpayment gift can cover the entire amount down in some cases. Check with your lender for gift and donor documentation requirements.
Without a gift, the applicant will need to verify a valid source of the downpayment such as a savings or checking account. Applicants can liquidate investment accounts and even use a 401k loan for the downpayment.
Typically, home buyers will need to supply a 60-day history for any account from which downpayment funds are taken.
Private mortgage insurance, or PMI, is required for any conventional loan with less than a 20% downpayment.
PMI rates vary considerably based on credit score and downpayment.
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% downpayment:
- 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.
Nationwide conventional loan limits stand at $424,100 and go higher in many locations.
For instance, Fannie Mae and Freddie Mac allow a loan amount up to $636,150 in Los Angeles County, California.
Home buyers who need a loan amount above the standard limit should check for the specific limit for their area.
The potential buyer’s debt-to-income ratio also plays a factor since it, too, can reveal good or poor financial prudence.
When it comes to buying a house, lenders factor in all debt to determine the total mortgage payment, including the loan, homeowner’s insurance, and real estate taxes.
Many lenders want this ratio to be less or equal to 36 percent of the borrower’s income, says Sam Mischner, senior vice president, sales and client management for Lending Tree in Charlotte, N.C.
But many lenders will issue loans up to a forty-three percent debt-to-income ratio, the limit set by recent federal legislation.
With a good credit score, you can qualify for more house and a bigger payment than you probably think.
Closing costs will involve fees such as a lender’s origination fee plus vendor fees like the appraisal, title insurance, and credit reporting fees, says Titsworth.
Sometimes, a lender or seller will pay all or some of these expenses depending on the strength of the market and desire to close the transaction.
Check whether your chosen lender offers lender credits, and make sure any seller contributions are within Fannie Mae and Freddie Mac guidelines. Typically, sellers and other interested parties can contribute the following amounts, based on the home price and downpayment amount.
- Less than 10% down: three percent of the purchase price
- 10 to 25% down: six percent of the purchase price
- More than 25%: nine percent of the purchase price
When buying a rental or investment property, the seller can contribute only two percent with any downpayment amount.