Whenever you want to buy something high-ticket, such as a house, you have two options: pay for it out of your own pocket or finance it through a loan. For a great majority of people, taking a loan is the best option because chances are they might not have the money. There are many loan programs that anyone can apply for, and one of those options is conventional loans.
A conventional loan, unlike other loans, can only be obtained through the private sector. Conventional loans account for a significant portion of purchases and refinance and are readily available with different types of mortgage lenders, such as banks, credit unions, and online lenders.
There’s a lot more to know about conventional loans, which we will be discussing in this article. Read on below to learn more.
More about Conventional Loans
Conventional loans come in two different types. The first type is the fixed-rate conventional loan, where your interest rate never changes regardless of the circumstances. The other variant is the adjustable-rate mortgage, where the rate changes depending on the predetermined market conditions.
The Requirements of a Conventional Loan
To qualify for any type of loan, a set of requirements must be met. Since conventional loans come from the private sector, they tend to have stricter requirements. These are:
The credit score is the fundamental part of any loan application process. Most mortgage lenders require a credit score of 620 to qualify for a conventional loan. However, that’s only the minimum. To get the lowest possible interest rate and best deal, you need to have a higher credit score. Ideally, your credit score should be at 740.
After your credit score has been evaluated, your lender will take a look at your debt-to-income (DTI) ratio. Your DTI ratio takes into account the other debts that you still need to pay for every month. These could be anything from credit cards, auto loans, or student loans.
Most lenders view 43 percent as the ideal DTI ratio, though some make an exception and allow up to 50 percent.
Your Down Payment
In a conventional loan, you won’t be able to get 100 percent of a home’s purchase price. In other words, a down payment is necessary. Many fixed-rate conventional loans for a primary residence allow down payments as small as 3 percent or 5 percent.
Let’s say that you’re looking to buy a house worth $350,000. If you’re taking a 3 percent down payment, you’ll need to pay $10,500 upfront.
Private Mortgage Insurance
While a 3 percent down payment seems like the obvious choice, it’ll have a repercussion in the form of private mortgage insurance (PMI). Since you didn’t make a 20 percent down payment, PMI safeguards the lender if you default. To put it plainly, you’ll need to pay the additional cost of PMI—be it through paying down the mortgage or increasing the home’s value—until you earn 20 percent equity in the property.
The final factor in getting a conventional loan is the amount of money you actually need. The Federal Housing Finance Agency (FHFA) sets standards annually, which can differ based on where the property is located. For most of the U.S., the limit for 2021 is $548,250. In some places where housing is valued higher, such as California and New York City, the limit is $822,375. If you go higher than that, then your loan will be more than you bargained for.
Types of Conventional Loans
- Conforming loans – Conventional loans that are within the FHFA’s limits. Fanie Mae and Freddie Mac, which are government-sponsored enterprises (GSEs), can buy conforming loans through the secondary mortgage market. When loans of this type are sold, lenders can have the capital needed to continue offering new mortgages.
- Jumbo loans – Jumbo loans are also called non-conforming loans because they exceed conforming limits. Unlike its counterpart, these loans can’t be sold to Fannie or Freddie. However, qualified borrowers can still get this if a flexible option is required.
- Non-qualified mortgages – These loans also can’t be sold to Fannie or Freddie, but it’s an excellent option for borrowers who can afford the mortgage but otherwise can’t meet credit or DTI standards.
If there’s no other option, taking a conventional loan might be the one for you. As long as you have good credit and follow the mortgage terms, you’ll have no problems when making the monthly payments. Just be sure to talk to multiple lenders and compare rates to find the best deal possible.
Century City Mortgage offers programs for home loans in Los Angeles. These include private money loans and reverse mortgage financing—all of which are reasonably priced. Contact us today to learn more!