Conventional Loans

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Conventional Loans

A conventional loan or mortgage is your average loan for buying home or property. It is any loan or mortgage that is not directly offered or secured by the government or any governmental bodies. The government bodies or entities usually include Federal Housing Administration (FHA), the United States Department of Veterans Affairs (VA) and the USDA Rural Housing Service. The conventional loans are not available through any of these bodies, but rather provided and guaranteed by private lenders (Banks, individuals, loan companies, mortgage companies) or any of the two government-sponsored companies that are Fannie Mae (the Federal National Mortgage Association) or Freddie Mac (The Federal Home Loan Mortgage Corporation).

Conventional loans are often known as conformal or conforming loans or mortgages but they are not always the same. Conforming loans are the loans that are guaranteed by either Fannie Mae or Freddie Mac but conventional loans don’t always have be sponsored by the two companies. So what this means is that while all conforming loans are conventional, not all conventional loans are conforming. To get guaranteed by Fannie Mae or Freddie Mac, the amount of the loan needs to be within their specified limits and one of their limits is the amount limit which is set annually by Federal Housing Finance Agency (FHFA). Although that amount varies from state to state, it is set the same for most of the country except for areas with higher priced homes and real estate. In 2019, the limit was set to $484,350. This is the limit that a lender would be guaranteed to be sponsored by Fannie Mae or Freddie Mac. If the limit was exceeded, the two companies won’t cover the loan and it will not be a conforming loan anymore. For example, a jumbo loan of let’s say $750000 would be a conventional loan but not a conforming loan because the limit is exceeded for it to be guaranteed by Fannie Mae or Freddie Mac.

Conventional loans make up for more than two-thirds of the market of the home loans issued in the United States.

Who qualifies for a conventional loan and what are the requirements?

Although the qualifications for a conventional loan have tightened, the base remains the same. There are no loans for people with no verifications, background or people who can provide no down payment. That’s all in the past.

Most of the basic requirements have remained the same. The borrower needs to apply for a conventional loan by completing an official mortgage application that usually has an application fee as well, then give the lender the necessary documents which would help the lender in checking the background of the applicant as well as making the lender can afford the loan based on the credit score and credit history. As you already know, no property is or can be 100% financed. By checking your assets, liabilities and other things your documents hold, the lender looks for possible downfalls or shortcomings on your part. The lender makes sure you can afford your monthly payments before approving the loan. The lender checks your background to see if you have any bad history with loans, payments or any relevant thing to make sure he doesn’t suffer later. Because no property is entirely financed, the lender needs to make sure you can make your monthly mortgage payments. These monthly mortgage payments shouldn’t normally be more than 28% of your gross income to make it easier on you and your life. More factors are considered such as if you can make a down payment on the property. If you can, then how much can you easily afford without breaking the bank and surviving easily. There are other costs as well that add up to the cause. These costs usually include underwriting fees, settlement or closing costs, broker fees and loan origination. These may sound like small fees’ but can drive up the price a lot higher than it originally was.

The required items or documents are the following:

  • Income proof. The proof in income documents require you to submit 30 days of pay stubs at least. In addition to that, an income statement is required for the current year as well as a federal tax returns statement that dates back to two years at least. A two month or three month all asset account statements is required as well that includes all of your accounts such as checking, current, savings and any investment accounts if any. Two years of W2 tax statements are required with all of these documents to ensure that you are a credible person. Any additional income needs to be reported as well. This additional income could be bonuses, alimony, gift or inheritance.
  • The second requirement for applying and qualifying for a conventional loan is assets. In your present bank statements that you provided and the investment accounts (if any) statements that you have provided, you will have to prove that you have sufficient cash reserves to make for the down payment as well as the other costs such as closing cost on the house you are going to buy. You need to show a sufficient cash flow as well in order to secure a loan. You will require to show all the money that you receive, if it’s salary, gift money, inheritance, bonuses or any other income you have that’s not a loan to prove that you don’t have to repay all or any of those which would become a liability. You will need gift letters if you have received gift money and other proof letters for other kinds of income to make sure your statements work in your favor and show that there are no loans to repay.
  • The almost late thing you need to provide is the verification of employment. In today’s world, lender’s want to ensure that the money they are loaning only goes to people who have a good history with work which is stable and hard working. In short, they need a credible and reliable person who will make the payments on time and not make any issue. This is the reason lenders want to see the verification of your employment and your employment history. The lenders not only want to see the pay stubs but also your salary and may even call your boss to verify your salary and your behavior at work ensuring you are still employed. Background checks are extremely important to ensure the safety of the money the lender is loaning you. If you’ve switched jobs, it wouldn’t be uncommon for a lender to call your old employer asking about your behavior and your history at work. In case of self-employment, it’s even harder and tougher to convince lenders. A good amount of extra paperwork is required concerning the business, income and stability of the business in the case of self-employment.
  • Lastly, some other documentation may be required to get your loan approved by your lender. The lender will require your driver license’s copy or the copy of your state ID card. Your social security number (SSN) and your signature will also be required. These are the minor details which will allow the lender to get your credit report and ensuring your credit score is above par.

Another thing to consider in conventional loans while getting the loan or qualifying for it are the interest rates. Remember, conventional loans are not government-backed mortgages hence they have higher interest rates. Loans such as FHA loans and other government backed mortgage systems have lower interest rates. The interest rate of a conventional loan or a mortgage depends on many factors that include certain things such as the term of the loan, the size of the loan, the length of the loan and whether the interest rate should be fixed or adjustable. More factors such as the financial and economic condition of the market is also taken into consideration. The lenders may set their interest rates as fixed or adjustable based on how they operate. The lenders may set the interest rates they offer based on how they expect the future to be or how the market might set in a direction in the future for inflation or financial purposes. Another factor that affects the interest rates are the supply and demand of the mortgage-backed securities. In a case when the banks find it more expensive to get or borrow money from the federal reserve through a larger federal funds rate, the banks put these costs that are higher than normal onto their customers and the customers have to pay extra. In short, the banks put the extra cost on the interest rates and hence the amount of loan rates go up which in the end, the customer has to pay.

More fees are connected to the interest rate such as the fees paid to the broker or the lender. These accumulate up points which affect your interest rate. The higher the points you have, the lower the interest rate you pay. Points are obtained by prices. A single point would cost 1% of the loan amount and hence reduce your interest rate by a significant margin. In the case of 1%, the interest rate goes down 0.25%. Generically talking, people who plan to live the home for long terms such as ten years or more should really consider the points system as it would affect the whole price a lot and make the interest rates lower for the life of the loan which would be longer in case of people who want to live in the home for long term.

The final thing that affects the interest rate is something we’ve already talked about. The borrower’s financial profile matters the most here. Credit history, current credit score, assets (personal), worthiness, credibility and the amount they can provide as down payment.

Among all these factors, to qualify for a conventional loan, you are likely to qualify if you fulfill these conditions:

  1. You should have a good credit score (at least 680 and preferably 700+)
  2. You have a good debt-to-income ratio (should be around 36% and is acceptable up to 43%).
  3. The down payment you can afford should be 20% or more than 20%.

Some things to consider are that the credit score is extremely important as a higher credit score ensures a lower interest rate. People with credit scores of 740+ get the best terms. Another thing to consider is that lenders do allow less down payment than 20%, it’s not preferred. If they do allow it, they often require that borrowers must take private mortgage insurance. Then the borrowers need to pay the monthly premium until they can achieve 20% equity of the house.

What is the down payment on a conventional home loan?

The down payment requirements for a conventional loan depends on the lender you are getting a loan from. Most lenders require at the very least 5% down payment while majority of the lenders operate with 10% – 20% down payments for loans of a higher amount. Freddie Mac and Fannie Mae created a program that provides loans with just 3% down payment.

Which is a better loan FHA or conventional?

FHA loans are comparatively better than conventional loans because of numerous reasons. Because FHA loans are government backed, they offer significantly lower interest rates, lower down payment, lower minimum acceptable credit scores (580 vs 680) and availability of down payment assistance programs that help you make your payments on time among other things. Another major advantage FHA has over conventional loans is that 100% of the down payment can be a gift from somebody while conventional loans only allow to make a portion of the down payment if there are gifts.

Is a conventional loan good?

This is a question that depends on many factors. Conventional loans can be good for some people and bad for some people. FHA loans are better than conventional loans in many ways but not everyone qualifies for FHA loans either. Although conventional loans have tougher requirements, they don’t require any upfront premium monthly insurance, they accept most properties, they have cheaper PMI one needs than FHA and they have a program that requires only 3% down payment. This all makes conventional loans good for people for whom it suits and who have a good credit score and history.

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