Conventional Mortgage

A conventional mortgage is a type of home loan that is not insured or guaranteed by the federal government. It is typically issued by banks, credit unions, and mortgage companies, and adheres to the guidelines set by government-sponsored entities like Fannie Mae or Freddie Mac. Conventional mortgages can be contrasted with government-backed mortgages such as FHA, VA, and USDA loans.

Components of a Conventional Mortgage

Down Payment

A conventional loan usually requires a down payment of at least 3% to 5% of the home’s purchase price. However, a 20% down payment is often recommended to avoid the need for private mortgage insurance (PMI). PMI is an additional monthly cost that protects the lender if the borrower defaults on the loan. High down payments can also help secure better interest rates.

Loan Terms

Conventional loans come with various term lengths, most commonly 15 or 30 years. The borrower can choose a fixed-rate mortgage, where the interest rate remains constant throughout the term of the loan, or an adjustable-rate mortgage (ARM), with an interest rate that can change periodically based on market conditions.

Interest Rates

Interest rates for conventional mortgages are influenced by various factors, including the borrower’s credit score, the size of the down payment, the loan amount, and overall economic conditions. Generally, borrowers with higher credit scores and larger down payments will receive more favorable interest rates.

Credit Requirements

To qualify for a conventional mortgage, borrowers typically need a credit score of at least 620, though higher scores will increase the chances of approval and better terms. Lenders will also scrutinize the borrower’s debt-to-income ratio (DTI), which should ideally be under 36%, though some lenders may allow up to 50%.

Loan Limits

The Federal Housing Finance Agency (FHFA) sets loan limits for conventional mortgages. These limits vary by region and are updated annually. As of 2023, the conforming loan limit for a single-family home in most parts of the U.S. is $726,200. Loans that exceed these limits are considered jumbo loans and typically come with higher interest rates and stricter qualification requirements.

Types of Conventional Mortgages

Conforming Loans

Conforming loans adhere to the loan limits and guidelines set by Fannie Mae and Freddie Mac. They are the most common type of conventional mortgage and usually come with competitive interest rates and more flexible terms.

Non-Conforming Loans

Non-conforming loans do not meet the guidelines set by Fannie Mae and Freddie Mac. This category includes jumbo loans, which exceed the local conforming loan limits. Non-conforming loans often have higher interest rates and stricter qualification criteria.

Advantages of Conventional Mortgages

  1. Flexibility in Terms: Conventional mortgage borrowers have a wide array of term lengths and structure options. This flexibility can accommodate various financial situations and preferences.

  2. No Private Mortgage Insurance (PMI) with 20% Down: Unlike FHA loans, which always require mortgage insurance premiums for the life of the loan, conventional loans do not require PMI if the down payment is 20% or more.

  3. Potential for Lower Costs: With good credit and a substantial down payment, borrowers might secure lower interest rates and monthly payments compared to government-backed loans.

  4. Higher Loan Limits: Especially with jumbo loans, conventional mortgages can accommodate higher-priced homes, making them suitable for affluent buyers.

Disadvantages of Conventional Mortgages

  1. Higher Credit Score Requirements: Conventional loans typically have stricter credit score requirements than government-backed loans, making it harder for borrowers with low or average credit scores to qualify.

  2. Larger Down Payments: While it’s possible to get a conventional loan with a smaller down payment, a 20% down payment is often recommended to avoid PMI, which might be challenging for some borrowers to afford.

  3. Stricter Income Requirements: Lenders may require more documentation and have stricter DTI ratios, making approval potentially more difficult for some borrowers.

Process of Getting a Conventional Mortgage

Pre-Approval

The first step in obtaining a conventional mortgage is getting pre-approved by a lender. This involves providing financial documents such as tax returns, bank statements, and proof of income. The lender will perform a credit check and provide a pre-approval letter indicating how much the borrower can likely afford.

Choosing a Lender

Borrowers should compare rates and terms offered by different lenders, including banks, credit unions, and mortgage companies. Online comparison tools can be helpful.

Application

After selecting a lender, the formal application process begins. Borrowers will need to submit detailed financial information and may need to provide additional documents as requested by the lender.

Underwriting

During underwriting, the lender assesses the borrower’s financial history, creditworthiness, and ability to repay the loan. An appraisal of the property is typically required to ensure its value meets the loan amount.

Closing

Once underwriting is complete, the lender will issue a closing disclosure outlining the loan terms, closing costs, and monthly payment. The borrower will review the document, arrange for homeowners insurance, and potentially conduct a final walkthrough of the property. At closing, all necessary documents are signed, and the loan is funded, allowing the borrower to take ownership of the home.

Refinance Options

Borrowers with conventional mortgages have the option to refinance their loans. There are two primary types of refinancing:

Rate-and-Term Refinance

This type of refinancing replaces the existing loan with a new one that has a different interest rate or loan term. Borrowers might opt for this to secure a lower interest rate, reduce monthly payments, or switch from an ARM to a fixed-rate mortgage.

Cash-Out Refinance

A cash-out refinance allows the borrower to take out a new loan for more than the current mortgage balance, receiving the difference in cash. This can be useful for funding home improvements, paying off high-interest debt, or covering other financial needs.

Conclusion

Conventional mortgages offer flexibility and potentially lower costs for financially stable borrowers who meet the credit, income, and down payment requirements. Understanding the different types of conventional loans, their benefits and drawbacks, and the process involved can help borrowers make informed decisions and secure the most favorable terms for their home purchase or refinance.