The Ins and Outs of Conventional Loans
- August 17, 2019
If you are looking for great rates and flexible underwriting rules, conventional loans may be a good option. You don’t need a 20% down payment to get this type of loan today. If you have good credit, minimal debts, and at least a 5% down payment (in most cases), you may qualify.
What is a Conventional Loan?
Conventional loans often have competitive interest rates, low mortgage insurance rates (if you put down less than 20%) and are available for most home types including single-family, townhome, and condominiums. Conventional loans are great for first-time home buyers but you can also use them to buy an investment property or second home.
You can typically find conventional loans as 15-year terms, 20-year terms, and 30-year terms. You may even find a few lenders that offer 10-year terms, but the payment must fit within your budget. You can also choose between a fixed rate (interest rate doesn’t change) and an adjustable rate (interest rate changes annually). The term and type of rate you get depends on your qualifications.
Loan Limits for Conventional Loans
Every year, the maximum loan limit for a conventional loan changes. In 2019, you can borrow up to $484,350. In most areas of the country, this is the most money any borrower can get. If you need more than $484,350, you would need what’s called a jumbo loan.
The loan amount you actually get approved for depends on many factors. How much is the property worth? Do you have a high enough credit score? Do you make enough income to cover your current debts plus the new mortgage payment?
Minimum Credit Score Requirement for Conventional Loans
Most lenders require a credit score of at least 620 for conventional loans. If you have a higher credit score you may get a lower interest rate or pay lower Private Mortgage Insurance (PMI) rates.
For example, if you have a small down payment (5% – 10% of the purchase price), ideally, you want at least a 680 credit score . If you have a large down payment (more than 25% of the purchase price), you may get away with a credit score as low as 640. Each lender has different credit score requirements, but at Achroma we match you with the right lender based on your qualifications.
Minimum Down Payment on Conventional Loans
You have many down payment options with conventional loans. If you put down less than 20% on the home, you will pay Private Mortgage Insurance (PMI) until you owe less than 80% of the home’s value.
Here’s how that works. Let’s say you agree to pay $200,000 for a home and you have $20,000 saved for a down payment. That’s a 10% down payment. The lender will require you to pay PMI (Private Mortgage Insurance) until you owe less than $160,000 or 80% of the property’s value.
If you put less than 20% down on the home, you may pay higher interest rates or fees. Lenders look at higher loan-to-value ratios (LTV) or the amount you borrow compared to the home’s value as an indication of your risk of not making your payments. The higher your LTV, the higher the risk of default becomes for lenders.
Some first-time homebuyers may qualify to make a down payment as low as 3%, though. If you haven’t owned a home in the last three years and have the qualifications for conventional financing, this may be an option we can explore for you. Check out our current mortgage rates for Conventional loans, or visit our mortgage finder to customize a loan for your needs.
Private Mortgage Insurance (PMI) on a Conventional Loan
As we discussed above, you can avoid PMI (Private Mortgage Insurance) if you put down at least 20 percent on the home. If you can’t quite make that 20% down payment, though, you’ll pay PMI temporarily.
The amount of PMI you pay depends on your credit score (the higher the better) and your loan-to-value ratio (the lower the better). Lenders look at the ‘big picture’ to determine your risk of default. Typically, borrowers that have lower credit scores and/or higher LTVs have a higher risk of default, so they pay higher PMI rates to offset the risk.
Maximum Debt to Income Ratio Requirements
Conventional lenders also care about your monthly debts compared to your gross monthly income (income before taxes), often referred to as DTI. The common rule of thumb is 28% of your gross monthly income can cover your housing payment and 36% of your gross monthly income can cover your total monthly debts.
Your total housing payment includes the principal, interest, real estate taxes, homeowner’s insurance, HOA dues (if applicable) and mortgage insurance (if applicable). Your total liabilities include minimum credit card payments, car loans, student loans, installment loans, alimony, and child support payments, along with your total housing payment.
Some lenders can stretch these guidelines slightly, allowing up to a 43% total debt ratio. This varies by lender and borrower, but at Achroma, we are the experts in matching you with an appropriate lender. You can create an account and use your dashboard for an interactive way of learning about the how your DTI can impact your mortgage.
Paying the Closing Costs on Conventional Loans
Conventional loans, like most loans, have closing costs. There are lender fees (origination, processing, and underwriting), and well as third party fees, such as title fees and appraisal fees. These are in addition to your down payment. Sometimes you can get help with closing costs with one of the following:
- Seller credit – Motivated sellers may give you a credit at closing to help cover a portion of your closing costs. You can receive between 3%-9% of the purchase price as a seller credit. On a $200,000 home, you could get a credit between $6,000 – $18,000.
- Rolling the costs into the loan – If the home you purchase is worth more than you agreed to pay for it, you may be able to roll the closing costs into your loan. You take out a larger loan, but you don’t have to come up with as much money at the closing.
- Lender credit – Lenders sometimes offer lender credits in exchange for a higher interest rate. You can negotiate with lenders to get help, but know that you’ll have a higher monthly payment and ultimately pay more in interest.
Allowed Property Types for Conforming Loans
Conventional loans are an option for almost any type of property including:
- Single-family homes
- 2-4 unit properties
You can use conventional financing on owner-occupied properties, investment properties, and second homes.
Conventional Loans Offer Many Benefits
When you are shopping for a mortgage, consider conventional loans as one of your options. Each lender has its own requirements, so let Achroma help you secure quotes from lenders that offer fair, transparent, and bias-free quotes that base your eligibility on your qualifying criteria alone.