Conventional Mortgage Loans: Rates and Requirements
A conventional home loan, also referred to as a conventional mortgage, is a home loan that isn’t backed by the federal government. Most mortgages are backed by a government entity, such as the Federal Housing Administration (FHA), U.S. Department of Veterans Affairs (VA), or USDA Rural Housing Service. However, a conventional mortgage is either backed by a private lender or one of two government-sponsored enterprises, the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac).
A conventional home loan is an option for a home buyer to finance his or her purchase, but the requirements and loan terms are different than other types of loans. Most conventional lenders require borrowers to have high credit scores and provide larger down payments than other loan types. These loans are often best for borrowers who have good financial standing but may need high loan amounts or other personalized loan characteristics.
The specific requirements for a conventional mortgage depend on the lender and the type of mortgage a borrower applies for. There are several types of conventional loans, including:
- Conforming loans: About half of all conventional loans are considered conforming loans because they conform to guidelines established by Fannie Mae and Freddie Mac, including maximum loan amounts.
- Non-conforming loans/jumbo loans: Non-conforming loans are conventional mortages that are also referred to as “jumbo loans” becacuse they’re offered to borrowers who don’t qualfiy for conforming loans due to high loan amounts.
- Portfolio loans: When lenders take on conventional loans and hold them within their own books, they’re referred to as “portfolio loans.” The lender sets its own guidelines for these loans.
- Subprime loans: Conventional loans that are provided to borrowers with low credit scores are called subprime loans. These mortgages are usually associated with high interest rates and fees.
Conventional Loan Requirements
Since conventional financing isn’t backed by the government, lenders usually set more stringent guidelines for borrowers to follow in order to qualify. Without the security of the government behind these loans, lenders are on their own in taking the risk. Therefore, these lenders set strict requirements that only some borrowers can meet.
The specific requirements for conventional loans vary by lender. Since these loans aren’t regulated by the federal government, each lender is permitted to establish its own guidelines and qualifications.
Most of the qualifications set for conventional mortgages include minimum credit scores or down payments. For example, a lender may only provide a conventional mortgage to a borrower who can prove he or she has a credit score higher than 680 and can provide a down payment that’s 20% of the loan amount.
For a borrower to prove he or she meets the lender’s qualifications for a conventional loan, the lender may require specific documentation to be provided, which may include:
- Proof of income.
- Verification of employment.
- Proof of assets.
- Social Security number.
With this documentation, the lender is attempting to determine if the potential borrower can afford the mortgage payments and upfront costs of the loan. With the borrower’s permission, the lender will also pull a credit report to review his or her credit history and score before deciding if the potential borrower qualifies for the loan.
Conventional Loan Limits and Down Payments
Conforming conventional loans are required to follow the guidelines and funding criteria set by Fannie Mae and Freddie Mac. The Federal Housing Finance Agency (FHFA) sets loan limit guidelines that these government-sponsored enterprises must follow and in turn, these guidelines must also be followed by lenders that offer conventional mortgages.
A loan amount cannot exceed $484,350, or $726,525 for single-family homes in Hawaii or Alaska. However, if the conventional loan is non-conforming, it doesn’t follow the guidelines set by Fannie Mae and Freddie Mac, and therefore, there isn’t a maximum loan amount for borrowers seeking a non-conforming loan.
In the past, the down payment required for a conventional loan was generally higher than what is required for a government-backed loan, such as an FHA loan. Traditionally, 20% of the loan amount was the standard down payment a borrower was required to provide at closing for a conventional mortgage. However, new conventional loan programs now offer these loans with down payment requirements as low as 3% of the loan amount.
These new programs were developed so that conventional lenders could compete with government-backed loans. However, to qualify for this significantly lower down payment, borrowers must meet stricter credit score and debt-to-income ratio (DTI) requirements. Some of these programs also have income regulations or require the borrower to be a first-time homebuyer.
Conventional Mortgage Loan Rates
The interest rates associated with conventional mortgages are usually higher than government-backed loans. This is especially true for non-conforming loans because these loans don’t need to follow the regulations set by government entities. Therefore, they carry more risk and lenders offset that risk by charging higher interest rates to borrowers.
There are several characteristics of the loan itself that can affect the interest rate offered, including the loan term, loan amount, and whether the loan comes with a fixed or adjustable interest rate. Additionally, the current state of the market and the lender’s outlook on the market’s financial future can affect the interest rate.
A conventional mortgage lender also looks at certain criteria related to a borrower when deciding on an interest rate. When determining qualifications and loan terms, a lender will analyze a borrower’s:
- Credit score and history.
- Ability to provide a down payment.
- Personal assets.
To improve your conventional loan interest rate, you can provide a higher down payment to lower your loan amount. You can also work on your credit to improve your score for a better interest rate on your loan.
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