How Do You Know It’s a Conventional Loan?
When approaching a mortgage company about taking out a mortgage, there can be a head-spinning amount of information that you will need to make sense of. While it is good to have more options to choose from, it is important to know what these options mean for you. One of these options is a conventional loan, which, as the name implies is your typical safe choice for a loan that most people opt for, especially in the aftermath of the recent housing crash. Conventional loans, as opposed to FHA, VA and USDA mortgages, are not insured or backed by any US Government entity. Although this translates into higher interest rates and strict eligibility requirements, this is something most people can go for, since this is the most commonly used type of mortgage. Mortgage loans like VA and USDA loans are only for a limited clientele (US Veterans and low/moderate income groups, respectively), and FHA loans have certain restrictions and downsides, which we will get into later.
A conventional loan is mostly regarded as the “plain vanilla” of all the mortgage types. No frills, no hypes, nothing exotic about this type of loan. It is offered by private lenders.
In short, a conforming loan (also referred to as conventional loan) is a mortgage loan that conforms to the guidelines set forth by the Government Sponsored Enterprises (GSE), Fannie Mae and Freddie Mac. The standard guidelines the GSE set for all borrowers include, but not limited to:
- down payment size
- credit score
- debt-to-income ratio
- documentation requirements
- loan limits
- Qualification Criteria
While the criteria are the same for most loans, conforming home loans have stringent requirements, as the government does not back these and they are not insured, putting a higher credit risk on the lenders. Different lenders can impose different requirements over and above the standard guidelines set by the GSE (often referred to as an Overlay). Depending on the property and risk standards, lenders will generally need to look at a borrower’s income as an ability to pay the mortgage, your debt-to-income ratio, your credit history, and credit score.
A borrower must have a stable income and employment history for a significant period of time (at least 2 years) and should not exceed the DTI ratio of 45%. All outstanding debts, including mortgage, insurance, taxes, student loans, and car loans should only amount to 45% or your gross income. All these determine if you will be able to make monthly mortgage payments. You will also need anywhere between 5% to 20% down payment. Having a 20% down payment exempts a borrower from any private mortgage insurance payments or PMI. Also, you should have a reasonable credit history and a FICO of at least 620 as set by the Freddie Mac and Fannie Mae, the 2 government-sponsored enterprises involved in the buying of mortgages. However, most lenders will require at least a 640 FICO, and anything lower can result in higher mortgage rates or a reason to decline the mortgage application.
Options Available in Conventional Loans
Conforming loans can be taken out for different periods of times, from 10 to 30 years, and anything in between. The time period will determine your monthly mortgage payments and interest rates, with longer periods resulting in higher interest rates but lower monthly payments and vice versa. The loan term can be decided through your debt-to-income ratio, which determines how many monthly payments you can afford. You can also decide whether you want a fixed rate mortgage (FRM), which offers a fixed interest rate throughout the term of the loan, or an adjustable rate mortgage (ARM), which means the interest rate can fluctuate. Both have their pros and cons, but fixed rate mortgage loans are usually more stable and safe as the borrowers know exactly what they need to pay every month; especially with current interest rates which are lower than ever, both ARM and FRM rates are almost at the same level.
Buying a home in Texas with a conventional loan might be less appealing to some people, with home prices much higher than the rest of the state, but this is probably the best option for most people, especially if your prospective home is in an affluent area. The loan limit placed on conventional loans by Fannie Mae and Freddie Mac, involved in buying most mortgages, is $424,100 for single-family homes. Compared to FHA loans, the loan limit is much lower depending on the county itself where the property is being purchased. In case your dream home’s price exceeds this limit, you can take out a non-conforming conventional loan, also called a Jumbo Loan, which will result in higher interest rates. With conventional loans, you can also buy a property for any purpose. This can be an investment property, a rental property, or even a vacation home. Compared to FHA, VA or USDA loans, you need the property to be your primary residence and must be owner-occupied.
Conventional Loans v.s. FHA Loans
While FHA loans have their appeal due to the lower interest rates, more flexible DTI at 50% and FICO requirements as low as 580, and a much lower down payment of 3.5%, there are many reasons why conventional loans can work better for most people. While the requirement for an FHA loan is more lenient, this is only due to the insurance the Housing Urban Development (HUD) provides that protect the lenders against default. This upfront mortgage insurance premium, set at a rate of 1.75% of the total loan amount, is paid for by the borrower and is rolled out into the loan amount and mortgage payments. This can make FHA loans more expensive than conventional loans, which don’t require any insurance as long as a down payment of 20% is made. This must be taken into consideration when making calculations for mortgage payments.
There are also other limitations on FHA loans in TX, such as the loan limit of $ 361,100, which is higher compared to other counties in Texas but is still much lower than the limit placed on conventional loans. Moreover, FHA loans only apply to owner-occupied properties. Plus, there are the loan term and types to consider as well, with ARMs and FRMs offering a variety of rates and options. These factors limit the housing options available to borrowers going for an FHA loan. The final decision you make will depend on what your specific requirements are, and which type provides you with a better deal, all things considered. You might be more enticed with low down payments of an FHA loan rather than the lower monthly payments when mortgage insurance is excluded in a conventional mortgage. Or you may not have the amazing track record required for a conventional loan at all. Whatever the final verdict, all this information is meant to do is to help you make an informed decision with the future in mind.
Contact our Home Loan Specialist for a free consultation. We will assess your specific needs and recommend which mortgage loan program suits your needs the best.