Conventional mortgages are loans that are not backed or insured by government agencies. They are also referred to as non-GSE (non-government sponsored entity) loans. These mortgages are offered and guaranteed by private entities like banks, credit unions and mortgage lenders.
They can however be offered by the two government sponsored entities, that is Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac).
How conventional mortgages differ from other mortgages
The main difference is that conventional mortgages are not offered by the government. This is in contrast to other mortgage facilities; the government insures Federal Housing Administration (FHA) loans and guarantees Department of Veteran Affairs (VA) loans.
Conventional mortgages are sometimes confused with conforming loans. This is because they share in some similarities. Conforming loans are loans that meet the funding criteria set by FHA for Fannie Mac and Freddie Mac.
Such criteria include maximum loan limits for mortgages in different regions of the country. On the other hand conventional loans are not affected by such limitations. This means that all conforming loans falls under conventional loans, but not all conventional loans are conforming loans.
Conventional loans typically come at much tougher terms compared to the government backed mortgages. Your credit score has to be higher than it would be expected when going for a FHA loan. You would also be required to pay a larger down payment than you would for the government backed loans.
Conventional mortgage attract interest rates that are higher than the government backed loans. They can however be cheaper in the long run considering that borrowers don’t have to pay PMI on the loan. PMI refers to Premium Mortgage Insurance which is an additional cost paid on top of monthly installments or as a large upfront for FHA loans.
Conventional mortgage requirements
Below are some of the things that you should take into consideration when going for a conventional mortgage;
Lenders have different conditions when it comes to credit scores. Typically a score of 620 is the minimum that can get you qualified for a conventional loan. However lenders may offer these loans to borrowers with credit score as low as 600 but at much larger down payments.
640 is the average minimum credit score requirement by most lenders for conventional loans. A score of 680 and above puts you in the ‘above average’ tiers that qualifies you for better rates. With 740 points and above, borrowers will qualify for the best and lowest interest rates in the market. To qualify for those rates you may want to consider repairing your credit prior to applying for a mortgage.
Conventional loans require down payments ranging between 3% and 20% of the home’s price. Down payment depends on your credit score, the principal amount that you qualify for, and your income. Normally, a credit score of 680 and above will get you a 95% financing.
If your score is lower than 680, the lender may require you to pay a larger down payment; say 10%. If you are in the below average tiers with credit scores between 580 and 640, your loan presents a high risk to the lender. To minimize the risk, you will be required to pay a higher down payment which can be up to 20% of the home.
Down payment also plays a big role in the overall additional costs of the loan. Borrowers who can’t afford the standard 20% down payment have to insure their loans. This insurance also known as PMI will greatly increase the eventual cost of the loan.
Debt-to-income (DTI) ratio
DTI is a measure of how much of your income goes to settling debts. The DTI ratio that lenders will accept for a conventional mortgage is up to 43%. Borrowers whose DTI is greater than 43% can also qualify for these loans. They may however have to pay more in terms of down payment. Their loans will also attract higher interest rates compared to those whose DTI is viewed as more favorable.
Applying for a conventional mortgage
The best approach when going for a conventional mortgage is to get pre-approved first. This gives you the chance to concentrate your rate shopping efforts on the homes that you are sure you can afford to buy. Having a mortgage pre-approval is also a good demonstration to the lender or real estate agent that you are serious.
Once you have the pre-approval letter, present it to different lenders with other documents such as;
- Bank statements
- Tax returns
- Investment statements e.g. 411(k) statements
This process is known as rate shopping and it allows you to exploit the best rates in the market. You get to close with a lender whose offer has the lowest interest rates and is less restrictive on other conditions.
Conventional mortgages are home loans that are not guaranteed by the government. They are less restrictive on the amount and can be a better option for borrowers whose credit history is above average. They can however be expensive due to high down payments and PMI that comes with having low credit scores. It’s advisable to do rate shopping before settling on a lender whose interest rates are considerably better.