A conventional loan, also known as a conforming loan, is a type of mortgage that is designed to meet the lending requirements of banks, mortgage companies and other private lenders versus sources that would back a more traditional home loan.
Although in certain situations, Freddie Mac and Fannie Mae, which are government insured corporations, can be listed as the guarantor on your conventional loan due to meeting specific criteria as well as meeting other stipulations.
How Does a Conventional Mortgage Work?
Getting a conventional mortgage requires submitting an application with a list of necessary documentation. This allows the lender to screen the potential homeowner on variables such as a background check, credit score risk, as well as overall long term stability to assess an overall financial picture for mortgage repayment viability.
In previous years, candidates could gain qualification via a set of outliers that bypassed full documentation, which were referred to as “no doc” or “no down payment” loans. However, with the vast increase of loan defaults following the housing bubble, regulations have more closely adhered to in order to avoid massive risk to lenders and/or property investors.
Conventional Loan Approval Requirements
The majority of housing loans are financed in some capacity and include down payments ranging from 3% to 20% of the principal loan amount in many cases. In addition to supplying the necessary documentation, a person seeking to obtain a conventional loan will typically have to produce a pre-approval letter, money for closing costs, and initial fees such as broker fees or origination fees.
Due to these types of loans not being secured by the federal government, you will often have much stricter rules and requirements to meet during the process. Conventional loans are also known for having fixed interest rates, allowing you to enjoy the same payment terms throughout the course of your loan.
Navigating the mortgage application process can be completed smoothly, and increase chances of underwriting, if the following items are presented in a satisfactory manner.
- Proof of Employment – One of the most important factors in determining suitability for any loan is financial stability. Lenders will assess your regular income as well as manually verify your likelihood of continued employment. Borrowers who are engaged in non-traditional forms of employment, such as freelancers or small business owners, will be required to to produce a substantial amount of documentation to compensate for irregular income.
- Asset Verification – Verification of assets can include a variety of documents including recent checking or savings statements from banking institutions. Other types of financial proof of mortgage affordability can be shown with investment accounts, brokerage accounts, stock holdings statements, or trust accounts from inheritances.
- Identity Documentation – As identity fraud has become prevalent in the past couple of decades, lenders will undoubtedly request full identity documentation including drivers licenses, social security cards, and additional items when applicable.
- Income Statements – Proof of income may come in many forms, with the most common being weekly or bi-monthly paycheck stubs. However, some mortgage companies may request alternative sources if recurring finances are lacking which can often include federal tax returns, annual wage statements, and quarterly bank statements.
- Satisfactory Credit Reports – A qualifying credit score will be one of the key factors in determining your propensity for handling financial affairs in a timely manner. Ideally, your score would range between fair (580) and excellent (720+) to improve your chances of a mortgage approval.
Types of Conventional Loans
Conventional loans come with several options to choose from when planning to purchase your new home. Knowing how each one works will allow you to decide the most optimal solution for your financial situation.
Conventional Jumbo Loans
Jumbo loans are designed for borrowers who need to secure financing for a large home purchase such as those within the range of $480,000 to $726,525. These types of loans also require you to have a credit score of at least 720 as well as an extremely low DTI or debt-to-income ratio. Lenders will also prefer a larger down payment initially due to the higher mortgage risk.
Adjustable Rate Conventional Loans
Adjustable rate loans are for borrowers who would prefer to put down a lower payment upfront, while paying off the loan over the course of the next few years. The interest rates on an ARM tend to be lower at the onset compared to fixed loans, due to the fact that they adjust on a periodic basis with rates based on market fluctuations.
Conventional Subprime Loans
Subprime loans are marketed towards homebuyers who have encountered credit blemishes in the past, or are in the process of rebuilding after a bankruptcy or other life situation. By not meeting the typical credit score requirement of 620, obtaining a loan will be challenging but lenders may approve it if other factors are satisfactory.
Portfolio loans are those that lenders do not resell for higher costs in alternative markets. These types of investments allow flexibility when it comes to loan terms, underwriting requirements, as well as approval factors. Although, they do not give you as many protections as a typical loan and must still meet the standards of government sponsored Freddie Mac and Fannie Mae.
Amortizing loans are designed to allow homebuyers to pay the same monthly amounts throughout the loan’s duration, without a change in payment terms. Being fully amortized, these loans allow for more budgeting flexibility with a consistent financial obligation, however they can be acquired with either adjustable rate or fixed interest rates.
Conventional vs Conforming Loans
Conforming loans are required to meet the terms of Fannie Mae and Freddie Mac, which oversee the affordability and stability of the housing market for borrowers. These types of loans cannot be written for more than $647,200 as of the current limits. Conventional loans, although they are very similar to conforming loans, however they are not always considered conforming. Certain types of loans such as jumbo mortgages or any others that exceed FHFA guidelines are considered conventional although they do not fit into conforming standards.
Conventional Loan Interest Rates
Loan rates for conventional mortgages tend to be contained within a certain set of guidelines. Due to the non-traditional lending approach of conventional loans and higher down payment requirements, much more competitive rates are offered to homebuyers considering this type of mortgage.
Currently, loan rates are between 4.75% and 5.5%,depending on the financing terms that you are approved for. When opting for a fixed rate conventional mortgage, you have the option to choose between 10-year, 15-year, 20-year, or 30-year loans. Lower interest rates often come with longer loan terms due to amortization schedule and market conditions.
Conventional mortgages are a solid option for those with a decent credit history, large down payment, and seeking to own a home in a HCOL (high cost of living area). By assessing your financial situation and comparing various lenders, you can determine what type of mortgage is right for you.