Conventional Financing for Your Home Purchase
A home purchase is a big deal. It is probably the largest transaction you’ll ever make in your lifetime. With so many types of financing available, it can often be hard to choose or know which type best meets your needs.
As great as many of the government-backed programs are, many individuals aren’t eligible and must go with conventional financing.
Here is an overview of conventional financing and what it entails.
What Are Conventional Loans?
Conventional mortgage loans are loans that are not guaranteed or insured by the government or a government program. Conventional loans are also known as conforming loans. This is because they must conform to the guidelines set by mortgage industry leaders Freddie Mac and Fannie Mae.
Freddie Mac and Fannie Mae purchase mortgages from qualifying lenders. They are then sold on the open market to other banks and lenders. This helps those lenders gain more capital to be able to provide more loans for home purchase.
Conventional loans come from banks, credit unions, and similar private lending institutions. They can be adjustable-rate or fixed-rate mortgages and may have terms from 10 years to 30 years. Freddie Mac and Fannie Mae set guidelines in the following areas.
- Type of home purchase
- Amount of income of the borrower
- Credit scores
- Maximum loan amount
- Required documentation from the borrower
- Debt-to-Income (DTI) ratio guidelines
Conventional Loans vs Non-conventional Loans for Home Purchase
Conventional loans are not guaranteed by government agencies such as the Federal Housing Administration or Department of Veteran Affairs. When a non-conventional loan is guaranteed or backed by the government, it means that the government agency agrees to pay the lender in the case that the borrower defaults on the loan.
Conventional loans must adhere to the various guidelines set by Freddie Mac and Fannie Mae. Conventional loans require a down payment that may be up to 20 percent. On a conventional loan, the borrower must have a DTI that does not exceed the bank’s requirements.
Conventional Loan Requirements
Because conventional loans are not backed by the government, they are riskier for banks and lenders and, therefore, have stricter requirements. To be eligible for a conventional loan for a home purchase, the borrower must typically meet the following requirements.
- Must have a down payment of up to 20 percent
- Credit scores must be around 600 or higher.
- The borrower must meet the lender’s minimum income requirements.
- Borrower’s DTI must not exceed the lender’s DTI maximum, which is usually about 43 percent.
- Loan amount must not exceed the guidelines. In most cases, the maximum is $424,100.
- Private mortgage insurance may be required depending on the LTV (loan-to-value ratio).
Advantages of Conventional Loans
Below are some of the advantages/pros of conventional loans.
- Private mortgage insurance is cheaper than with non-conventional loans.
- There is no PMI required upfront on conventional loans.
- When mortgage insurance is required, it can be eliminated when the LTV reaches 78 percent of the home’s value.
- There is no down payment required if borrower puts 20 percent down, which can come by way of the home’s value. For instance, if the loan amount is less than 80 percent of the home’s value, that amount can be equivalent to the down payment.
- Home buyers can borrow up to $424,100 or $625,500 in higher cost areas.
- The home can be found in almost any area.