If there’s one truth about home buying after the housing market crash, it’s been anything but conventional. That’s because lenders tightened their grip on loans, making qualifications stricter, and therefore leaving most first time homebuyers with little choice other than going the FHA mortgage route. While that program has benefitted many Americans over the past few years, some of them missed out on the opportunity to attain a conventional loan, which offers lower overall costs.
This past July FHA loans comprised only 20 percent of home mortgages according to a report by loan software giant Ellie Mae. During the same month, conventional mortgages equaled 64% of all home loans. Thanks to low conventional loan rates, an improved housing market, and a loosening of lender restrictions, more homebuyers are finding conventional loans to be an accessible and superior option.
What Exactly is a Conventional Loan?
Conventional mortgages differ from FHA and VA loans in that they conform to rules set by Fannie Mae and Freddie Mac. That is why conventional loans are also known as conforming loans.
Fannie Mae and Freddie Mac are agencies that are currently owned and controlled by the federal government, but government doesn’t officially back or insure the loans for which they set rules. As such, homebuyers must have strong credit scores and come up with larger down payments than with FHA or VA. Lenders require more “skin in the game” from borrowers since they are taking a greater risk without any government guarantee in place. Conventional loans can be conforming or nonconforming, fixed or adjustable rate, and they are widely available from most lenders.
As compared to other loan programs like FHA and VA, it’s typically a little more difficult to be approved for a conventional mortgage. But the higher standard means lower costs for the borrower. For instance, borrowers who put down less than 20 percent need private mortgage insurance, which is typically half the price of FHA mortgage insurance. Buyers who put down 20 percent or more do not need to pay mortgage insurance at all.
Conventional Loan Rates
Some applicants find it surprising that conventional loan rates are slightly higher than those available for FHA and VA loan programs. This is because, as mentioned above, conventional loans are not guaranteed by the government. But borrowers should not look at the rate alone. Monthly payments on conventional loans are actually lower than payments on an FHA loan, despite slightly higher rates. This fact is due to FHA’s fairly high mortgage insurance fees. VA loans offer incredibly low rates and are a fantastic value, but they are only available to current and former U.S. military service members.
Conventional loans provide a good combination of low payments and flexibility and are the right choice for many home purchase and refinance applicants.
What are the Perks of a Conventional Mortgage?
Because lenders are choosy about who is eligible for a conventional loan, overall costs are lower than they are for FHA borrowers. As an example, an FHA borrower pays a fee equal to 1.75% of the loan amount upfront plus 1.35% yearly. That’s an extra $6,200 during the first year for a $200,000 FHA loan. Conventional loan borrowers don’t pay this huge fee.
Conventional loans also offer more repayment options than with FHA. Most lenders offer 15- and 30-year FHA loans, and a 5 year adjustable rate mortgage, or ARM. With conventional, borrowers can choose loan terms from 10-30 years, or choose a 3-, 5-, or 7-year ARM.
Conventional loans are also available in bigger loan amounts. The standard loan limit for Fannie Mae and Freddie Mac loans is $417,000, but up to $625,500 in some areas of the country. While FHA allows increased loan limits, it’s standard limit is only $271,050.
One more perk: applicants can use a conventional mortgage to buy or refinance an investment property or second home. This option is usually not available with FHA or VA.
How do you know if you will Qualify for a Conventional Loan?
Even though it’s becoming slightly easier to qualify for a conventional loan than it was a few years back, it’s still not a solution for all borrowers. Conventional loan requirements are not geared toward people with poor credit histories, or those who wish to buy a home with a very small down payment. Conventional loans require a minimum 5% down payment.
Plan to pull out the pay stubs, tax returns, and other documents to prove that you are a worthy candidate. Your mortgage payment and other debt also need to be less than 43 percent of your gross monthly income. Some lenders may vary this debt-to-income ratio (DTI) a bit, so shopping around is always recommended. Keep in mind, however, that DTI is important to lenders since it’s a good indicator as to whether you’re going to be able to make your monthly payments on time.
Apply for a Conventional Loan
For people who can show a steady income, have strong to excellent credit scores, and can put down at least 5%, a conventional loan will likely offer the best terms.
Low conventional loan rates are available now. In fact, rates are currently at 2014 lows.
The low costs and long-term benefits of a conventional loan will put your home purchase or refinance goals within reach.