When the majority of people imagine a mortgage, they are actually thinking about a conventional home loan.
The conventional loan is the closest one can get to the “standard” mortgage. These loans are not associated with any special eligibility requirements, and just about all mortgage lenders provide them. You can also qualify for one of these loans with a 620 credit score, and 3% down. Due to their wide availability and low rates, the conventional loan is perhaps the most common mortgage when it comes to home refinancing and buying.
What Are the Requirements for a Conventional Loan
The loan requirements for conventional loans typically vary from one lender to the next, but every conventional loan is required to match up to specific guidelines that have been set by Fannie Mae and Freddie Mac:
An income-to-debt ratio that is lower than 43%
A credit score of 620 or more
A minimum down payment of 3%
The amount for a conventional loan must be within the conforming loan limit, which is usually up to $548,250 in the majority of areas but can be higher in a few of the high-cost ZIP codes. If you have higher credentials when applying for one of these loans, such as a 740 or even higher credit score, and you can put down a 20% down payment, you will more than likely be offered lowered monthly payments and a lower interest rate. If you only just qualify for a loan, and your credit score is close to 620, with a high level of debt, it is important to compare what each lender is willing to offer you.
Mortgage lenders are allowed to set up their own rates and requirements for a conventional loan provided they stay within conforming loan limits that are set by Fannie and Freddie. This means that it is possible to find lenders that offer a better rate and are more flexible to match up to your unique situation.
What is the Minimum Down Payment for a Conventional Loan?
One of the myths surrounding conventional loans is that you will need a minimum down payment of 20%. Today it is possible to get a loan with a small down payment of just 3%. Currently, there are 6 main mortgage options when it comes to the down payment requirement for conventional mortgage loans, that range from 3%, all the way up to 20%.
Some of these conventional loan types include:
Conventional Loan without PMI: 20% Down Payment
Conventional Loan with PMI: 5% Down Payment
Piggyback Loan (no PMI): 10% Down Payment
Freddie Mac Home Possible Loan: 3% Down Payment
Conventional 97 Loan: 3% Down Payment
Fannie Mae HomeReady Loan: 3% Down Payment
From Conventional 97 Loans to HomeReady and 10% Down Piggyback Loans, low-down-payment options are not only extremely popular but also readily available to many loan borrowers.
The 20% Down Payment Myth
The myth surrounding the 20% requirement for a down payment most probably comes from the shoppers that prefer to avoid having to pay for PMI (private mortgage insurance) premiums. If your down payment is less than 20% on your conventional loan, the lender requires you to have PMI. This is coverage that helps to protect lenders when the borrower defaults on his/her loan. PMI will increase your mortgage payments. However, this is usually the best option if it has allowed you to secure one of the conventional loans, using a “down payment” that you can actually afford.
It is also important to note that you can cancel your conventional PMI at a later stage, as soon as your home has reached a minimum of 20% equity. This means that you won’t be stuck with these payments forever.
What are Conventional Loan Rates?
Conventional loans are associated with lower rates that often makes the process of buying a home a lot more affordable.
Daily Conventional Mortgage Rates for 9.23.21
30 Day Range 2.5% - 3.096%
30 Day Range 2.248% - 2.338%
*Calculated from actual locked rates with consumers across more than one-third of all mortgage transactions closed nationwide
The rates for conventional loans are based heavily on the credit score of the applicant (even more so than the rates for the FHA loans). For example, if the home buyer has a 20% down payment and a credit score of 740, they will typically secure a 0.50% lower rate when compared to buyers with scores of 640. These rates are also worked on MBS (mortgage-backed securities) that are traded in a similar way to stocks. And just like stocks, the rates for conventional loans change consistently throughout each day.
Keep a Watch On the Markets to Secure the Lowest Rates
One of the best approaches to make sure you secure the lowest rates is to keep an eye on market movements, which will allow you to monitor the rates. The rates for conventional loans can rise or drop very quickly when any financial news is released to the market. For example, if the Federal Reserve has decided to cut the benchmark rate, this would cause the rates for conventional loans to fall.
The rates worked out on the 30-year conventional loans that are fixed have stayed under 3.5% for a while now, and these rates shouldn’t increase above these levels anytime soon. However, the lowest of rates are made available to those that are prepared to “lock in” once the rates have dropped. Any applicant that is already mortgage-approved that has chosen a property that they are interested in purchasing is able to “lock-in” a rate.
It is very important to obtain personalized rate quotes. The rate averages that are published are mainly based on “perfect” applicants, which are people with large down payments and great credit scores. Your personalized rate quote may be lower or higher. It is worth your while to obtain a minimum of 3 quotes in writing from different mortgage lenders, regardless of the length of the loan, or the type of conventional loan you have chosen. According to a government study, the applicants that took the time to shop around, often receive rates that are up to 0.50% lower compared to those that don’t shop around.
Your rate quote for a conventional loan should apply to your information rather than that of the “average buyer”.
The Advantages of Conventional Home Loans
The conventional loan is the most common and popular mortgage type. After this comes the government-backed mortgages, which include USDA, VA, and FHA loans. The government-backed mortgages offer a few unique benefits such as credit guidelines that are more flexible and smaller down payments. Many first-time buyers often require this type of leeway.
However, conventional loans often outshine the mortgages that the government agencies subsidize in many ways.
For instance, conventional mortgage loans offer various types of repayment plans and the borrower does not have to match up to “special” criteria such as geographic location or military status in order to qualify. There is also no upfront fee required for mortgage insurance.
Flexible Repayment Plans
Similar to other types of mortgages, conventional loan products provide multiple repayment options.
Conventional mortgage loans are available in 15, 20, 25, and 30-year terms. Some of the lenders even provide 10-year conventional mortgage loans. The monthly payment on loans is higher with the shorter loan terms. Luckily, the fixed-rate 30-year conventional loan is linked to fixed-interest low payments that are still accessible to most home refinancers and buyers.
Available Adjustable Rates
A conventional loan is a better option for people that know they don’t plan to stay in a house for very long and who want an adjustable-rate, shorter-term mortgage. This is an option that features an interest rate that is even lower than fixed-rate loans.
The adjustable-rate loan is also fixed, but only for a few years, which is usually 3, 5, or 7 years. During what is known as the initial “teaser” period, the owner of the home will pay an ultra-low interest rate which can help the borrower to save thousands.
Today, many buyers of homes often select a 5-year ARM or a 7-year ARM. This type of loan can result in significant savings while allowing the buyer of the home ample time to either sell the property, refinance to one of the fixed-rate loans, or even pay their mortgage off entirely.
However, once the introductory low rate expires, the interest rate on the loan and the monthly payments made towards the mortgage may increase or decrease each year, which will depend on current market conditions.
This is why the ARM loans are regarded as risky for owners of homes, and is one of the options that requires very careful consideration.
No Special Requirements Needed to Qualify
In certain respects, a conventional loan is regarded as the “least restrictive” loan type.
Unlike a government-backed mortgage, a conventional loan is not attached to any special requirements. They are made available to any applicant that has a stable income, an adequate credit score, and enough money for the down payment. The loans that are government-subsidized have a specific purpose and are usually linked to several limitations:
For example, USDA loans are available only in certain designated “rural” areas. This can work for the home buyers that work and live in rural and suburban locations. However, for people that work in a major city, a USDA-eligible home may result in commuting distances that are beyond anything reasonable.
The VA loans are only available to former and current members of the military. These loans provide many benefits including no mortgage insurance and zero down payments. Yet this loan type is not available for the rest of the population.
FHA loans are often regarded as a powerful home-buying tool. However, they are associated with mortgage insurance costs that are high and payable over the lifespan of the loan (which could be up to 30 years). To cancel FHA mortgage insurance the borrower would need to refinance their FHA loan, which would then require having to pay closing costs (again).
In addition, many federal government loan programs cannot be used to buy a second home or for investment properties. They are more focused on helping American citizens to purchase single-family houses that they use as their primary residence. Repeat and first-time buyers can often secure great value when choosing one of the conventional loans to purchase their home, and a lot more buyers actually qualify for these loans than one might expect.
No Upfront Mortgage Insurance Fee
Conventional loans won’t require a mortgage insurance fee upfront, even when your down payment is less than 20%.
USDA mortgages, FHA loans, and even VA loans require the insurance fee upfront, which is typically between 1% and 4% of the total loan amount. Conventional mortgage loans will only require mortgage insurance premiums that are paid monthly, only if the homeowner has put down under 20%. At the same time, mortgage insurance on a conventional loan might be lower when compared to a government loan if your down payment is decent and you have a good credit score.
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The Pros and Cons of Conventional Loans
Qualifying for a Conventional Loan
Many potential home buyers are under the impression that it is difficult to qualify for conventional mortgages, especially when their financial affairs are less than perfect. But that is not really the truth.
Similar to the “easy” government-backed loans, the process of qualifying for one of the conventional mortgage loans means that you have to prove that:
You are earning enough to cover your monthly payments
The income that you earn is guaranteed or “expected” to continue
You have enough money to cover your down payment
You have a decent credit score and your credit history is good
The standards that apply to successfully qualify for conventional loans may be slightly higher when compared to VA or FHA loans, but they are also more flexible which enables most buyers of homes to qualify.
Credit Score Needed for a Conventional Mortgage
According to Ellie Mae, one of the loan software companies, the credit score average for applicants that complete mortgages successfully is around 720. This is more than high enough to qualify for conventional loans.
In fact, the credit score minimum for the majority of conventional mortgage products is just 620. Staci Titsworth, the regional sales vice president manager from PNC Mortgage based in Pittsburgh, PA, states that they want to know that applicants are financially disciplined, that their bills are paid on time, and they know how to manage their money.
Slightly lower credit scores might just pass a credit-score test. However, in these cases, the lenders usually charge higher interest rates that usually compensate for the increased risk. The applicants that have a lower credit score may be better off choosing an FHA loan, that does not charge higher rates or extra fees for credit scores that are lower. Make sure you have checked on your most recent credit report well before you start applying for mortgages so that you are aware of where you currently stand.
Income and Employment
During the application process for a mortgage, the home buyer is required to provide proof of what they earn, which can involve a few or all this type of documentation:
2 year’s W2s
30 day’s pay stubs
An offer letter, when it hasn’t been started yet
Proof of education if you are a new graduate
Titsworth says that the majority of lenders will ask for two years of documentation to prove a consistent income stream. Alimony can also count when documented in the “divorce decree”, which must also include recurring methods of payment like automatic deposits. Seasonal income is also usually accepted when it can be proved in your tax return.
Lenders will not approve mortgages for amounts that exceed what the home is worth. Before they close on any loan, lenders will have the property appraised to determine the true value.
For example, if a buyer has offered to pay $200,000 for a property, but once appraised the property is valued at $190,000. In this scenario, the buyer can use the appraisal to ask the seller if they will lower their price to what the lender is willing to finance. Or, the buyer could choose to pay this extra $10,000 from their own funds to balance the lowered borrowing limit. This $10,000 would then be added to a down payment that the buyer has already agreed on paying.
For example, if the buyer has a down payment of 20% on a $200,000 property, that would be $40,000. But the appraisal value is only $190,000. The buyer would then need to make a down payment of 20% of this new value, which would be $38,000, along with the shortfall of $10,000, which means the total cost of the down payment would be $48,000.
Value is just one of the things to take note of when obtaining an appraisal for a conventional mortgage loan. In some cases, during the inspection, an appraiser may request the opinion of another professional. Titsworth states that when an appraiser notices leaky faucets and water stains on the ceilings or wall, they may ask for a professional plumbing inspection. This may result in the seller having to make some improvements to the property, which may delay the closing. However, most conventional loan products are associated with property requirements and appraisals that are less strict when compared to USDA, VA, or FHA loans.
This is one of the other advantages to conventional loans, that buyers may qualify for homes that are in less-than-perfect (slightly worse condition) and make plans to conduct the necessary repairs once the loan is successfully approved and they have moved in.
Down Payment needed for a Conventional Loan
The down payment from the borrower often affects not only their interest rate but also the final costs of the loan.
The larger the down payment, the lower the monthly payment for the mortgage costs. The down payments of 20% or more also do away with CMI (conventional mortgage insurance). In comparison, USDA and FHA loans will require that the buyer has mortgage insurance even when they have a down payment of 20% or more.
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Must be below or at the median income for a geographical area, unless the property is situated in an under-served area.
10% Down payment 90% Loan
One Loan. PMI required.
Piggyback 80/10/10: 10% Down payment, 10% Second Mortgage, and 80% Conventional Loan
No PMI is required.
3% Down Payment Home Possible Advantage with “income restrictions”
Provided by Freddie Mac Home Lenders.
Down Payment Gift
The applicant can receive a percentage of their down payment “as a gift” from a family member or any other eligible sources.
Conventional Loan Products with Just 3% Down
Many of the conventional loans are created with just 3% down.
For example, the HomeReady Mortgage program is one of these options. It provides a way for non-borrowing members of a household to assist the applicant of the loan to get approved. Lenders may consider income from fathers, mothers, non-married partners, or extended family, even when their names do not officially appear on the applicants’ loan file. The Conventional 97, provides a way for a home buyer to borrow 97% of the price of the home. Unlike the HomeReady option, this loan type is available to applicants on all types of income levels that want to buy a property in any area or location.
Are There Drawbacks to the 3% Down Loans?
Interest rates can be higher on a 3% down loan that compensates for the amount put down. The mortgage insurance can also cost more when compared to the 10% or 5% down conventional mortgage loans.
How to Avoid PMI with the 80/10/10 Loan
The Piggyback 80/10/10 loan allows the applicant to skip both the 20% full down payment in addition to mortgage insurance
How? The applicant will first apply for a mortgage for 80% of the “purchase” price. At the same time, they will open a secondary mortgage, like a HELOC (home equity line of credit) for 10% of the “purchase” price. From here, only a 10% down payment is required since the lender allowed the borrower to use the 10% loan to contribute towards the down payment of the original loan. Combined, the secondary mortgage along with a cash total of a 20% down payment, does away with the requirement for “mortgage insurance premiums”.
How to Source Your Down Payment
Conventional loan borrowers have the choice to put anything from 3% to 20% down or even more. At the same time, a Down Payment Gift may cover the whole amount in certain cases. Check with a loan officer for donor and gift documentation requirements. Unless it is a gift, applicants are required to verify a source that is valid where the down payment will be coming from such as their checking or savings account.
Applicants also have the option to liquidate an investment account or use a 401k loan to cover their down payment. In most cases, the home buyer will be required to submit a 60-day history for the account that the down payment amount will be taken from.
PMI (Private Mortgage Insurance)
PMI or private mortgage insurance is a requirement for all conventional loans with a down payment that is less than 20%. PMI rates can vary significantly based on the down payment and the applicant’s credit score. For example, one of the PMI companies is currently quoting these rates (at the time of writing this article), for example,
a 5% down payment and a $250,000 loan amount: 660 credit score: $295 per month 740 credit score: $123 per month
Here are the quotes for the 10% down payment: 660 credit score: $208 per month 740 credit score: $85 per month
The high mortgage insurance premiums for the borrowers that have low credit scores often prompt these buyers to use the FHA loans. Unlike the conventional loan, an FHA loan does not charge a higher insurance rate, even when the applicant has a very low score.
One of the other factors that can affect PMI rates is the mortgage insurance agency itself. In most cases, the lender will choose a PMI company, and each company can charge a different rate. However, applicants do have a bit of say when it comes to choosing a PMI company. If the applicant knows of a PMI company that provides a better deal, they should ask the lender if they work with them.
If not, most lenders will try to provide an offer that is similar to other PMI providers, or the applicant can go with another mortgage lender that is already working with the PMI company they have chosen.
Loan Limits on Conventional Loans
The nationwide loan limit on conventional loans starts at $548,250 but can go higher according to the location.
For example, Freddie Mac And Fannie Mae allow loan amounts to go up to $822,375 in some of the high-priced ZIP codes. The applicants that require loan amounts that exceed the standard limits should check on the limit for that specific area. The loans that exceed the conventional loan limit of an area are known as non-conforming loans. These usually require what is known as a “Jumbo Loan” rather than a conventional mortgage loan.
The applicant’s DTI (debt-to-income ratio), will also play a role when it comes to qualifying for a conventional loan.
DTI compares the monthly debts of the applicant (total), which includes mortgage costs, to the applicant’s gross income. This figure is then used to work out what type of mortgage payment is going to match the applicant’s monthly budget. Most lenders want the ratio to either be equal to or lower than 36% of the income of the borrower. However, some of the conventional loan products can allow a DTI of up to 43%.
To work out your DTI ratio add all your payments together, including:
Minimum Payments on Credit Cards
Your “projected” Mortgage Payment
Don’t forget to add in alimony payments or child support that you make payments to every month (when applicable), then divide this amount by your pre-tax monthly gross income.
Conventional Loan Closing Costs
The closing costs on a conventional loan typically include an origination fee from the lender, along with vendor fees including title insurance, credit reporting fees, and the appraisal. In some cases, the seller or lender will pay some or all of the expenses which usually depends on how strong the market is or when there is a strong desire or urgency to close a transaction. Find out from your chosen lenders whether they provide lender credits. You should also ensure that any contributions from the seller fall within the Freddie Mac and Fannie Mae guidelines.
In most cases, the seller or any other interested party can contribute towards certain amounts, which is usually based upon the amount of the down payment and the price of the home.
A down payment of less than 10%: 3% of the “purchase price”
Between 10 and 25% down payment: 6 % of the “purchase price”
Over 25% down payment: 9% of the “purchase price”
With investment or rental properties, the seller is only allowed to contribute 2% of the “purchase price” to pay towards the closing costs.
Government Loans Vs Conventional Loans
Today, homebuyers have several loan options to choose from to secure a mortgage. But in general, mortgages fall under 2 broad categories. These include conventional loans and government-backed loans.
In most cases, if your credit score is 680 or higher, and you have a down payment of 5% or more, conventional loan products are often the best option. If on the other hand, your down payment is smaller, and your credit score is low, one of the government loans may be able to help. Yet these are not regarded as universal rules. The ideal mortgage that matches up to your needs depends on your credit, home-buying goals, and your budget.
To give you more guidance, here is an overview of the government loans Vs conventional loans, and what type of people they are best for:
These are privately-backed loans that are usually affordable for homebuyers with a down payment of 5% or more and a credit score above 680. However, conventional mortgage loans can also work for applicants with a credit score of 620, and down payments of only 3%.
The jumbo loan is designed for people interested in buying a high-priced home. This will include any of the loan amounts that exceed the “conventional loan limits” in the majority of areas. You will usually have to have a 700 credit score or higher to secure one of these loans.
FHA loans are loans that the Federal Housing Administration backs. They are designed for people that have a credit score of between 580 to 680. The down payment for these loans must be at least 3.5%.
The VA loans are only available to qualified military and veteran members. They allow applicants to purchase a home with 0% down, and the interest rates are exceptionally low, along with no mortgage insurance monthly payments.
These are known as zero-down loans that are made available in some of the suburban and rural areas. They are reserved for applicants with a moderate-to-low income, and they usually come with below-market interest rates.
If you are still unsure about the loan that is best suited to your needs, talk to one of the loan officers, or find out more about each option to find out what you may qualify for.
At the end of the day, it is essential for any home buyer to compare their options to secure a conventional loan, by approaching at least 3 lenders. The current rates are extremely low, and you could even find a lower rate when you know what you are looking for. Check on your eligibility for a conventional loan and the rates today.
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