Are you a responsible current or future homeowner who’s been preparing for your purchase by polishing up your credit score, increasing your income and paying down your debts? Have you managed to save up a down payment? Maybe even spent some time daydreaming about the perfect neighborhood you’d like to live in but aren’t sure what the next steps are to make your purchase a reality . You have heard the words ‘conventional mortgage’ thrown around and have no idea what they mean or if it’s your best option. Well maybe a conventional is the right fit for you!
What is a conventional mortgage?
Conventional mortgage loans offer a unique opportunity for borrowers to become homeowners with more favorable terms. The program has stricter guidelines compared to other loan programs but can be more affordable depending on your financial situation (income, credit score, debts). You will often see down payment requirements as low as 3% – 5% in most cases. One thing you need to know about a conventional home loan is that it is not guaranteed by Uncle Sam. There are a few differences from government backed loans like FHA, VA, and USDA that you need to understand. These loans may be a bit tougher to get and can have more stringent qualifications , but the benefit may be worth it.
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These are the questions you should be asking yourself at this stage:
Have I been responsible with my credit, income and debts?
Do I have any past credit events like late payments, charge offs/collections, bankruptcy or foreclosure?
Do I have a debt load compared to my income?
I’m I comfortable with a 3% to 5% down payment?
At this point, it’s good to fully understand and unpack what’s involved with qualifying for a conventional home loan so you can approach the home approval process with confidence.
Conventional Mortgage Loan Requirements
Income – Your monthly mortgage payment, including taxes and fees, should not exceed 36 % of your total income. If you combine this with your other debts ideally it should not exceed 50% of your gross monthly income .
Financial History – Your lender will want to look at two years of income, including W2’s and pay stubs. If you’re self-employed, your lender may require profit & loss statements or tax returns. You’ll also need to provide identification (drivers license or social security card).
Credit Score – Your credit score (FICO) should be 680 or above. If your credit score falls below this, you may have a difficult time acquiring this type of loan. Even if you do qualify you may end up paying more on your mortgage compared to other programs due to a lower credit score.
Down Payment – Traditionally its been 20% of the cost of the home. The good news due to new conventional programs like HomeReady and Home Possible you ca n qualify for as little as 3% – 5% down. You can also use gift funds from a family member to help with your down payment and even cover the closing costs.
Cash Reserves – Typically you want to have at least two months worth of mortgage payments available after your down payment and closing costs requirements are met.
Sales Price – Loan limits for conventional loans in most counties is $548,250. But a Mortgage Broker can find you a loan for a home price exceeding these limits if needed. These are called Jumbo Loans. Of course, the higher the Mortgage, the tighter the qualifications become
Bankruptcy or Foreclosure – Although it’s possible to qualify for a conventional loan after a bankruptcy, foreclosure, or short sale there are required waiting periods along with needing to show established credit. (see below)
Chapter 7 Bankruptcy: A four year waiting period, starting from the discharge date is required
Chapter 13 Bankruptcy: A two year waiting period, starting from the discharge date is required
Foreclosure: A seven year waiting period, starting from the discharge date is required
Short Sale or Deed-in-Lieu: A four year waiting period, starting from the discharge date is required
Types of Properties Allowed
Single family homes (SFR)
Planned Unit Developments (PUDs), think Townhomes
Multi unit (duplex, triplex, quadruplex)
Second homes and investment properties
Getting the Best Interest Rates for Your Conventional Mortgage.
Once you’ve been pre-approved for your conventional mortgage, your mortgage advisor will start shopping to find the right mortgage that fits your needs.
Fixed Rate Mortgages
Consider a fixed rate mortgage if this is a home that you expect to live in more than 5 years. These can range from 10, 15, 20, 25 or even 30 year terms. For people in this current climate of low interest rates, many are locking into a fixed mortgage. The beauty of a fixed mortgage is you know your mortgage payment will be the same for the life of the loan.
Adjustable Rate Mortgages
Although adjustable rate mortgages have great low rates. They add risk since the interest rates could rise at the time of adjustment and your payments would increase along with your total cost of home ownership. If you know that you may not be living in your home for more than 5 years it could be the right option for you to lower your mortgage payments by taking on a lower rate than a traditional fixed rate mortgage.
3 types of Adjustable Rate Mortgages:
Traditional ARMs – Your interest rate is a low teaser rate at signing and then gradually increases based on the agreed upon terms.
Interest Rate Only – You only pay the interest each month. It switches over to principal and interest as per your agreement with the lender.
Hybrid ARMs – These are usually ‘3/1’, ‘5/1’, ‘7/1′ or ’10/1’. They are fixed for 3, 5, 7 or 10 years and then adjust every year after your negotiated time period.
A few things to consider before signing ARMs:
Starting Interest Rate – The initial rate at signing
Adjustable Period – This is when your loan moves from being fixed to variable.
Index – The cost to the mortgage lender to borrow the money. Choose a slow changing index like (COFI) because, as your lenders rate climbs so does yours.
Life-of-the-Loan Cap – The highest interest rat e your mortgage can go up to.
Periodic Cap – Limits how much the interest can adjust in a one year period
Low Margin – The mortgage lenders profit margin – usually around 2.75 %.
Prepayment Penalty – A penalty for paying your mortgage off early, often around six month’s mortgage payments.
Interest rates – 3 areas to consider:
The Base Interest Rate – The rate the mortgage professional secured for you with the lender.
The Annual Percentage Rate (APR) – The total cost including closing fees, divided over the number of years of your loan. This rate is higher than the base interest rate which your mortgage payment is attached too.
The Lifetime Cost of the Loan – Basically how much you will pay over the term of the loan for principal and interest.
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