When it comes to buying a home, many people opt for types of conventional loans since they offer flexible options. However, understanding the different types and requirements can help home buyers make informed choices. Here’s what you need to know about types of conventional loans.
What is a Conventional Loan?
A conventional loan is not insured by government agencies like a Federal Housing Administration (FHA) loan or a Department of Veterans Affairs (VA) loan.
Instead, conventional loans follow guidelines set by Fannie Mae and Freddie Mac. These are government-sponsored enterprises that purchase mortgages from lenders and sell them on the secondary mortgage market to provide liquidity.
It’s worth noting that most conventional loans typically require a higher credit score and larger initial payment compared to government-backed loans. The minimum credit score is usually around 620, and the down payment ranges from 3 to 20%.
Most homeowners select amortized conventional loans, which means that you make a regular monthly payment on both the principal and interest. These are typically safer than interest-only products that come with balloon payments at the end of the term.
Conventional loans are adaptable and offer many choices to suit different financial circumstances and borrowing requirements. They're known for their versatility in accommodating diverse situations. For instance, a borrower with excellent credit and ample income may qualify for a conforming conventional loan with competitive rates and terms.
On the other hand, those with unique financial circumstances, like self-employment or investment property ownership, might find a non-conforming conventional loan better suited to their needs, such as portfolio loans.
These loans often have more flexible underwriting guidelines but may come with higher interest rates or larger initial payment requirements. Some of these are considered subprime loans, which can come with significant risk.
Conventional Loan Requirements
To qualify for a conventional loan, borrowers must meet several crucial criteria aimed at assessing their financial stability and repayment ability. Not all conventional loans have the exact same process, but here’s what you need to know in general.
1. Down Payment Requirement
Conventional loans necessitate a more substantial down payment in comparison to government-backed financing options. This financial contribution, which can span from 3% to 20% of the property's total value, is dictated by the lender's guidelines and the borrower's unique financial profile.
Providing a 20% down payment means that you won’t have to provide private mortgage insurance, which can significantly reduce your monthly mortgage payments. However, this can be a significant upfront expense that makes it challenging to pursue a conventional mortgage.
If you’re struggling to provide 20% upfront, our team at Pride Lending can help you find local, state, and national down payment assistance programs to make up the difference.
2. Debt-to-Income Ratio (DTI)
A pivotal consideration in the loan approval process is the borrower's debt-to-income ratio, a metric that gauges their capacity to shoulder the proposed loan obligations while managing existing financial commitments. Debt-to-income ratios are integral to the conventional loan process.
In general, lenders will want a DTI of 43% at the maximum. The average DTI for a Black or Hispanic borrower is above 46%, while it is only 26.5% for white families. LGBTQ+ individuals carry, on average, $16,000 more debt than their cisgender or heterosexual peers, which can also make it a challenge to access loans. However, Pride Lending can assist you in finding lenders that will work with your current DTI.
3. Credit Score
A good credit score is essential in order to qualify for a conventional loan. Most lenders insist on a minimum credit score of 620, but having a higher one can increase your likelihood of being approved for a good loan amount and enable you to benefit from lower interest rates.
Those with lower credit scores than this may consider FHA loans, which allow for scores as low as 500 to qualify. We can assist you in deciding whether you’d like to pursue government-backed or other mortgage loans.
Sadly, borrowers of color may struggle to get a conventional loan even if they have a great credit score; in fact, Black borrowers are 1.6 times more likely to be denied than their peers with the same profile, especially in certain metropolitan areas. LGBTQ+ individuals also have approval rates that are 3% to 8% lower than the general population.
Pride Lending is here to be your ally and advocate, ensuring that every borrower has a fair chance at purchasing a home.
4. PMI (Private mortgage insurance)
Private mortgage insurance is required when you close on the house and pay less than 20% deposit. PMI typically safeguards the lender if you default on your loan. PMI is cancelable once you have enough equity in your home.
5. Loan Size
Your loan limits may be lower with a conventional loan. The Federal Housing Finance Agency (FHFA) sets loan limits that vary by location and can change annually. A conforming loan must meet these standards.
Conforming vs. Non-Conforming Loans
When discussing conventional loans, knowing the difference between conforming and non-conforming loans is important.
Conforming Loans
These types of loans follow Fannie Mae and Freddie Mac guidelines, such as maximum borrowing limits, borrower credit scores, and debt-to-income ratios. A conforming loan has a major advantage because it can be easily sold on the secondary market, thus attracting more competitive interest rates for borrowers.
Most conventional loans are conforming loans because they are more secure; as such, conforming loans require less paperwork and only one appraisal as compared to non-conforming conventional mortgage loans.
Conforming conventional loans must be below the conforming loan limits, which the Federal Housing Finance Agency sets by county. FHFA loan limits range from $766,550 to $1,149,825, depending on the local market.
As LGBTQ+ borrowers spend an average of $245,000 on their home, this limit may not pose a challenge except in very high-cost areas. Regardless, if you find yourself stifled by the limits, we can assist you in finding a different product to meet your needs.
Non-Conforming Loans
These loan types do not meet the standards of Fannie Mae and Freddie Mac. This includes jumbo loans. A jumbo loan typically exceeds the maximum allowable size for mortgages set by those organizations, called the conforming loan limit.
Qualifying for non conforming conventional loans (e.g., jumbo loans) can be more complicated than conventional ones, usually requiring borrowers to pay interest rates that are higher, not forgetting a larger initial payment.
Types of Mortgages for Conventional Loans
When you want to buy a house using a conventional loan, it’s crucial to understand the available mortgage types. The government does not insure or secure conventional loans, making them a common alternative among borrowers with good credit and steady income.
Two main types of mortgages are available in conventional loans: Fixed-Rate Mortgages (FRMs) and Adjustable-Rate Mortgages (ARMs). Each has unique advantages to ensure you get the best credit score. Here are the types of conventional loans.
Fixed-Rate Mortgages (FRMs)
One of the easiest and most commonly used types of mortgage is the fixed-rate mortgage (FRM). In fact, 83% of LGBTQ+ borrowers purchased their homes with fixed-rate conventional mortgages.
In this type of mortgage, the interest rate does not change for the entire loan term. Of course, this type of stability has multiple advantages.
For one, fixed-rate conventional loans ensure that payments are the same each month during the loan's duration. This is especially useful when creating a budget and planning for the future. Homeowners can keep track of their mortgage payments every month and manage their household financial matters more easily without being caught off guard by any sudden increases or decreases in housing costs.
Secondly, fixed-rate loans are predictable and stable. Unlike Adjustable-Rate Mortgages (ARMs), which can have interest rates that vary over time, FRMs lock in the interest rate at the beginning of the loan. This means borrowers are protected from potential interest rate increases in the future. For those who value financial predictability and wish to avoid the risk of rising rates, FRMs are an ideal choice.
However, it's worth noting that FRMs can have higher initial interest rates than ARMs. This higher initial rate can mean higher monthly payments in the short term. Nonetheless, many borrowers find the trade-off worthwhile for the long-term stability and peace of mind that FRMs provide.
FRMs are particularly well-suited for borrowers who plan to stay in their homes for an extended period. The predictability and stability of a fixed-rate mortgage make it a smart choice for those who don't anticipate moving or refinancing soon. It's also a good option for conservative borrowers who prefer the security of a consistent payment plan.
The most common FRM options are the 30-year and 15-year fixed-rate products. The 30-year option spreads payments over a longer period, resulting in lower monthly payments but higher overall interest costs.
On the other hand, the 15-year fixed-rate mortgage typically comes with a lower interest rate and allows homeowners to build equity faster, although the monthly payments are higher.
Adjustable-Rate Mortgages (ARMs)
Adjustable-rate mortgages (ARMs) offer advantages that can appeal to certain types of borrowers. Unlike a fixed-rate product, ARMs have interest rates that fluctuate over time based on a chosen index, such as the LIBOR or the U.S. Treasury index. This means that the monthly payments can vary, which introduces uncertainty and offers distinct benefits.
One of the primary benefits of an adjustable-rate mortgage is the lower initial interest rates it offers compared to FRMs. This lower initial rate can make homeownership more affordable in the loan's early years. An ARM can provide significant savings for borrowers who expect their income to increase over time or who plan to sell or refinance before the adjustable period begins.
However, it's important to understand that the interest rate on adjustable-rate conventional loans can increase over time. After an initial fixed-rate period, typically 3 to 10 years, the rate will adjust periodically based on the market index. This adjustment can lead to higher monthly payments if interest rates rise, a risk borrowers must consider.
ARMs are suitable for borrowers with short-term homeownership plans or who are confident in their ability to manage higher interest payments in the future. They are also good for those anticipating a higher income, such as young professionals who expect career advancement and salary increases.
There are various ARMs, including the 5/1 ARM, 7/1 ARM, and 10/1 ARM. The numbers indicate the initial fixed-rate period and how often the rate adjusts after that. For example, a 5/1 ARM has a fixed rate for the first five years and then adjusts annually. Understanding these options can help borrowers select an ARM that suits their financial strategy and risk tolerance.
Other Conventional Loan Options
When exploring mortgage options, it's crucial to consider the variety of conventional loan programs available to potential homebuyers. Unlike government-backed loans, conventional loans are not insured by a federal agency such as the Federal Housing Finance Agency.
Instead, they are offered through private lenders, like banks and credit unions, and typically adhere to guidelines set by government-sponsored enterprises like Fannie Mae and Freddie Mac. These loans can be an excellent choice for many borrowers due to their flexibility and the range of options tailored to different financial situations and needs.
Low Down Payment Conventional Loans
For many prospective homeowners, saving up a large deposit can be daunting. However, conventional loan options require as little as a 3% deposit. These options make homeownership more accessible, especially for first-time buyers.
One key consideration with these loans is the requirement for private mortgage insurance (PMI). PMI protects conventional lenders in case the borrower defaults on the loan, as they can’t rely on the government to help them like they could with VA, FHA, and USDA loans.
While PMI adds an extra cost to the monthly mortgage payment, it enables buyers to purchase a home sooner without waiting to save a larger down payment.
Conventional 97 Loans
One of the most popular low-down payment options is the Conventional 97 loan program. This program allows for a down payment of just 3%, making it an attractive option for first-time homebuyers with a good credit history but who may not have substantial savings.
The Conventional 97 loan is notable for its relatively lenient requirements compared to other conventional loans. Even with low credit scores, conventional loans make this program more accessible to a broader range of borrowers.
Fannie Mae HomeReady and Freddie Mac Home Possible
Fannie Mae’s HomeReady and Freddie Mac’s Home Possible loan programs offer excellent options for low-to-moderate-income borrowers. These programs are designed to help more people achieve homeownership by providing flexible credit requirements and lower PMI costs.
HomeReady and Home Possible loans are tailored to meet the needs of individuals and families with limited income, often including provisions that allow for income from non-borrower household members to be considered in the loan application. This flexibility can make a significant difference for those on the cusp of qualifying based solely on their income.
Considerations for Conventional Home Loans
Several key factors will affect your overall borrowing experience and financial health when considering a conventional home loan. Understanding the terms, potential for refinancing, and implications of PMI can help you make a more informed decision.
Loan Terms
Conventional loans typically have varying term lengths, the most common being 15, 20, and 30 years. The length of the loan term directly impacts your monthly mortgage payment and the total amount of interest paid over the life of the loan.
A shorter loan term, such as 15 years, generally has a higher monthly payment, resulting in less overall interest. Conversely, a 30-year term offers lower monthly payments but will accrue more interest over time.
Refinancing Conventional Loans
Many homeowners consider refinancing to lower their interest rates, reduce monthly payments, or change the terms of their loans. Refinancing a conventional loan can be beneficial, especially if interest rates have dropped since they originally took out their mortgage.
However, if you plan to refinance a loan, it also comes with costs and potential downsides - such as closing costs and the risk of extending your loan term. Evaluating these factors can help you decide if refinancing is right for you.
Private Mortgage Insurance (PMI)
PMI is typically required for conventional loans with a down payment of less than 20%. This insurance protects the lender but adds to your monthly costs. The good news is that there are ways to cancel PMI once you have enough equity in your home, usually when your loan-to-value ratio drops to 80%.
Additionally, some loan programs may offer lower PMI costs, and certain strategies, such as making a slightly higher down payment or opting for lender-paid mortgage insurance, can help you manage this expense.
Summary
Navigating the world of conventional loans involves understanding various options and considerations to make the best choice for your financial situation. Low down payment loans, such as the Conventional 97, and programs like HomeReady and Home Possible offer viable paths to homeownership for many buyers.
Key factors like loan terms, the potential for refinancing, and the implications of PMI are crucial in making an informed decision.
Pride Lending is proud to assist borrowers from all backgrounds in accessing conventional mortgages. Our team is composed of allies and members of marginalized communities, including LGBTQ+ and BIPOC individuals, who are familiar with the challenges that you may face in seeking mortgage loans.
We’ll help you find the right product for your specific goals, whether that is conventional renovation loans or portfolio loan products for investors. We’ll also help you untangle the differences between different conventional products, such as adjustable-rate loans and fixed-interest-rate loans.
If you’re ready to get started on your homeownership journey, call us at 725-231-0192 or email us to discuss your specific needs. You can also apply online to learn exactly what you can afford.
FAQs
Can You Pay Off a Conventional Loan Early?
Yes, most mortgage lenders allow borrowers to pay off up to 20% of the loan balance yearly without incurring prepayment penalties. This can help reduce the total interest payment and shorten the loan term.
How Many Times Can You Use a Conventional Loan?
You can use a conventional loan multiple times, typically between 4 to 10 times, though the qualification requirements become stricter with each new loan. This is often due to the increased debt-to-income ratio and the lender's risk assessment.
Can You Do 3% on a Conventional Loan?
Yes, with the Conventional 97 loan program, backed by Fannie Mae, you can secure a conventional loan with a down payment as low as 3%. This program is ideal for first-time homebuyers with good credit.
What Is the Maximum Amount I Can Borrow Using a Conventional Loan?
The maximum loan amount you can borrow depends on the loan limits in your area. These limits are set annually and vary based on the cost of living and housing prices in different regions.
Can You Get Down Payment Assistance With a Conventional Loan?
Yes, down payment assistance programs are available and can be used with conventional loans. These programs are designed to help first-time homebuyers or those with limited savings cover the down payment and closing costs.
Our team at Pride Lending can help you find local, state, and national assistance programs that make accessing conventional mortgages more feasible.
Comments