Conventional Loans are mortgage loans that are not insured by the government (like FHA, VA, USDA Loans), but they typically meet the lending guidelines that have been set by Fannie Mae or Freddie Mac. Conventional loans typically require a borrower to have good-to-excellent credit, reasonable amounts of monthly debt obligations, a down payment of 3% or more and reliable monthly income. Conventional loans are ideal for borrowers with excellent credit and at least a 3% down payment.
Private mortgage insurance
When you put less than 20% down on a conventional loan, a lender will require private mortgage insurance (PMI). This coverage helps protect the lender if you default on the loan.
PMI does increase monthly mortgage payments. But that’s OK if it allows you to get a conventional loan with a down payment you can afford. Also, note that conventional PMI can be canceled later depending on certain conditions.
Debt-to-income ratio
The buyer’s debt-to-income ratio (DTI) also influences conventional loan qualifying. DTI compares your total monthly debts (including mortgage costs) to your gross monthly income. A lender uses DTI to determine how much a mortgage fits within your monthly budget.
Many lenders want this ratio to be less or equal to 36% of the borrower’s income. However, conventional loans may allow a DTI as high as 49%.
To find your debt-to-income ratio, add up your loan payments, including:
Then Divide that sum by your gross monthly qualifying income.
Employment and income requirements
During the mortgage pre-approval process, home buyers must provide proof of earnings for the last 2 years to show their income is consistent. This 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
2 year’s bank statements
An offer letter, if you’ve not yet started a new job
Proof of education for new graduates
Alimony can also be counted if documented in a divorce decree, along with the recurring payment method, such as an automatic deposit. Seasonal income is also accepted with proof in a tax return.
Property requirements
A lender won’t approve a mortgage for an amount greater than the home’s value. Before closing on the loan, the lender will appraise the property to determine its fair market value.
As an example, let’s say a buyer has agreed to pay $400,000 for a home, but the appraisal comes in at $380,000
In this case, the home buyer should use this appraisal as a bargaining chip to get the seller to lower the price to a level the lender will finance
Or, the buyer could pay the additional $20,000 out of pocket to compensate for the lower borrowing limit. This $20,000 would be added to the down payment you’d already agreed to pay.
Property value isn’t the only thing to watch for when getting a conventional loan appraisal. Sometimes during a home 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,
However, conventional loans have less strict appraisal and property requirements than 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.
Fixed Rate Mortgages: Your rate and payment never change.
Adjustable Rate Mortgages: After the initial period your interest rate can change once a year.
For Purchase transactions Conventional Loans require the home-buyer to put down at least 3% - 20% of the purchase price of the home. For a Refinance transaction, most lenders require at least 5% equity in the property.
Most conventional loan programs allow you to purchase single-family homes, warrantable condos, planned unit developments, and 1-4 family residences. A conventional loan can also be used to finance a primary residence, second home and investment property.