Conventional Home Loan Basics
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A conventional home loan is simply a loan that is not guaranteed or insured by the government. A conventional home loan can be a conforming loan, meaning that it follows the guidelines of Fannie Mae or Freddie Mac, or it can be non-conforming, meaning that it does not follow these guidelines.
So, what are Fannie Mae and Freddie Mac? They are mortgage associations that lend money to your lender so that your bank can make more loans. They have very specific guidelines for lending, so if your lender wants to work with Fannie Mae or Freddie Mac, they will be sure to make your loan conform. Since most lenders want to work with Fannie and Freddie, most conventional loans are conforming loans.
Conventional Home Loan Requirements
Because of these specific guidelines, getting a conventional home loan can be tough. Here are the things you will need in order to comply with the standards:
The Right Front-End Debt-to-Income Ratio: This is your housing costs (mortgage, taxes, homeowners insurance, homeowners association fees, and mortgage insurance premiums) divided by your gross monthly income (money you make before taxes or deductions). This ratio must be 28% or less.
The Right Back-End Debt-to-Income Ratio: This is your monthly debt payments (mortgage payment, credit cards, car loans, student loans, child support, and other regularly scheduled monthly bills, not including groceries, gasoline, entertainment, or utilities) divided by your gross monthly income. This ratio must be 36% or less.
An Excellent Credit Score: A minimum FICO score of 620 is needed. However, having a score of 740 or higher will get you better interest rates. You must also have an overall pattern of good credit.
Verified ID: You must have either a driver’s license or Social Security card. You will also have to provide your address history for the last two years.
Employment History: Prove your income with tax returns, W-2 forms, and pay stubs. If you are self-employed, you will need 1099 forms, profit and loss statements, and tax returns.
Enough Down Payment: The standard down payment for a conventional loan is 20% of the cost of the home. You can put down less, as little as 5% if you are willing to pay private mortgage insurance, which protects your lending institution in case you do not make your payments.
Two Kinds of Loans
There are two kinds of conventional loans: fixed-rate loans and adjustable-rate mortgages (ARM).
Fixed-rate loans are the most common type of conventional home loan. A fixed-rate mortgage has interest that stays the same for the entire loan period. With this type of loan, you will also know exactly how much the principal and interest payment portion of your monthly payment will be. A fixed-rate loan is a great option for those that plan to stay in their home for several years.
Fixed-rate mortgages can be 30-year, 20-year, and 15-year loans. Longer termed loans have lower monthly payments. However, longer terms also mean spending more in interest over the life of the loan.
Adjustable-rate mortgages (ARMs) have interest rates that adjust over the period of the loan. These loans have a fixed rate for a period of 3, 5, 7, or 10 years and then adjust to the new interest rates. If the rates have fallen, then your new rate will fall as well. However, if the rates have risen, your new rates will rise. If interest rates are low, and you plan to stay in your home for a short period of time, an ARM might be ideal for you. Not only will you keep the constant low interest rate for a period of time, but most ARMs are structured so that the first few years of payments are smaller than payments later in the payment cycle.
Why You Might Consider a Conventional Home Loan
There are many reasons that people with good credit choose a conventional mortgage over government-backed loans. Here are a few:
- A conventional home loan can be processed faster.
- Sellers like to take offers from buyers using a conventional home loan because it shows they have good credit.
- If you need to pay private mortgage insurance (PMI), it will cost less than with a government-backed loan and will drop off you loan faster.
Having worked in real estate, we understand the basics of a conventional home loan. Feel free to contact us with questions or for a recommendation for a mortgage broker in our area.