Understanding Conventional Mortgages
The word ‘conventional’ doesn’t always inspire confidence, except in mortgaging. Statistics show that over 60% of home purchases are done using conventional home loans. Additionally, in a house bidding war, the person with a conventional mortgage is more likely to win compared to buyers with other types of mortgages.
That boils down to one thing – conventional mortgages are incredibly flexible.
Lenders offer a variety of highly customized mortgage packages that are easy to qualify for. With the current real estate market showing stability, it is possible to get a conventional home loan with as little as 3% down and less-than-perfect credit score.
Plus it takes a very short time to process and approve a conventional mortgage. That is why home buyers and sellers alike prefer this type of mortgage.
With that in mind, what exactly is a conventional mortgage? Simply put, it is a type of home loan that is not guaranteed or insured by the government. Some other loans (particularly the FHA, VA, and USDA) are backed by the government. In these cases, the government takes some risk on behalf of the lender in the case of default. But in the case of conventional mortgages, the lender assumes the risk.
Fannie and Freddie the primary guarantors of conventional mortgages. The two (Fannie and Freddie) are also responsible for regulating and standardizing conventional mortgages. They determine such things as lending limits and play a role in influencing rates and FICO requirements.
The Two Types of Conventional Home Loans
A conventional home loan can either be a fixed-rate mortgage (FRM) or an adjustable-rate mortgage (ARM).
Here are brief descriptions of the two:
An FRM is a type of loan whose interest rate remains the same for the entire term of the mortgage. Whatever rate is charged on the mortgage loan when you are taking it out, will remain constant for the whole life of the loan.
The advantage of a fixed rate is that it keeps your monthly payments constant and predictable. You will pay the same amount even when national mortgage rates increase. In short, you will be immune to market changes and increase in real estate rates won’t affect you.
The downside is you won’t be able to take advantage of lower interest rates, if they drop. Only those with ARMs will enjoy.
The interest rate charged on an ARM usually changes depending on the market conditions. When you take out an ARM, the rate charged on your home loan will be significantly lower than the rates charged on FRMs. However, after some time (usually 5 to 10 years), your rate will be adjusted upwards and you may end up making a higher monthly payment than someone who initially took out an FRM.
The good thing about an ARM is that when market rates drop so do the interest rates charged on your loan. So it makes a great option when the rates can only go down.
Reasons to Choose a Conventional Mortgage
Whether you choose an ARM or FRM, a conventional mortgage comes with many benefits that every homebuyer should consider taking advantage of. Here are the main pros:
• Flexible qualifications: compared to government-backed mortgages that have stringent qualification standards, conventional home loans can be tailored by a lender to meet borrower needs.
For example, nowadays there are conventional loans that only require 3% down instead of the usual 20%. You can also request for a manual underwrite and you may get approved even with a relatively low credit score and income (which automated systems usually disapprove).
• Streamlined underwriting process: if you want a mortgage loan that will take a very short time to close then your best bet is a conventional home loan. These loans are simple and straightforward because they are created and originated internally by the lender.
Not like government-insured loans which are managed by public agencies like the FHA, VA, and USDA. The latter (government loans) require many steps that involve verification, appraisals, inspections and other checks that make the closing process last longer.
• ARM and FRM are both available: for a conventional loan, you can choose between an ARM and an FRM. Your pick depends on your financial plan. Additionally, you can get various loan terms ranging from 5 years to 30 years. Some lenders have even introduced 50-year FRMs for borrowers who are looking far into the future.
• Optional mortgage insurance: you will not be required to pay monthly mortgage insurance if you put 20% down. In case you can’t afford to raise that down payment you can go ahead and pay mortgage insurance. But, it will be cancellable as soon as your home’s equity hits 80%.
• Very few limitations: conventional mortgages are available for first-time homebuyers as well as repeat buyers. You can use your mortgage to purchase any type of property, including an investment property.
• Preferred by sellers: the kind of mortgage loan you have will play a role in influencing a seller to either accept or reject your bid. Most sellers generally prefer the simplicity of conventional loans. They are more likely to accept bids from buyers with conventional loans compared to other types of mortgages.
Because conventional mortgages are created by lenders, their requirements vary (at times widely) from one lender to another. It is entirely possible to negotiate for relaxed qualification standards and even request for manual underwriting. While that may put the loan within reach, regardless of your creditworthiness, there are still certain conditions to be fulfilled.
1. A maximum debt-to-income ratio of 43%. Some lenders will consider you if your debt-to-income ratio (DTI) is 50% as long as you have strong compensation factors, such as a lot of savings or very high credit score.
2. Minimum down payment of 3%. That is just the base minimum; meaning you won’t find a lender who is willing to go below 3%. The actual amount of down payment varies from one lender to another, but it lies between 3% and 25%. The more down payment you have, the lower the interest rates you’re likely to be offered. If it is more than 20%, you won’t have to pay private mortgage insurance (PMI).
3. While the standard credit score requirement is at least 620, it is possible to get a conventional home loan with a score of 580 if you have a sizeable amount of savings and income.
Will Chapter 7 bankruptcy affect your qualification for a conventional mortgage? The answer is no, but at least 4 years should have passed since the bankruptcy.
Here are other considerations to keep in mind:
- You will be required to pay closing costs. They include fees for appraisal, insurance and credit reports among many other things. Note that it is possible to negotiate with your lender to either cover them or roll them in the loan. If they choose to cover closing costs, they may increase your interest rates as compensation.
- Although the loan limit varies from one region to another and from lender to lender, it ranges from $424,100 to $815,650. That means in some places the maximum you can borrow is $424,100, but if it is a high-cost area the limit goes to $815,650.
Is Your Property Eligible For Finance?
While other types of mortgages limit the type of property you can purchase using the loan; conventional mortgages don’t. You can use it to purchase:
- 1, 2, 3 or 4-unit home
- Second home
- Rental or investment property
- Manufactured home
- Planned unit development (PDU)
- Co-op property
The bottom line is that a conventional mortgage is a good alternative for government-backed home loans. Its flexibility and relaxed qualification requirements make it a popular choice for many.
Is a conventional mortgage right for you?
Contact Mortgage Right and we will help you determine that. Our mortgage experts will check to see whether you meet the requirements and how much you qualify for. They will also advise on the steps to take to increase your odds of getting a conventional mortgage.