A conventional mortgage loan is one that’s not guaranteed or insured by the federal government. Most conventional mortgage loans, aka conventional mortgages, are “conforming,” which simply means that they meet the requirements to be sold to Fannie Mae or Freddie Mac. Fannie Mae and Freddie Mac are government-sponsored enterprises that purchase mortgages from lenders and sell them to investors. This frees up lenders’ funds so they can get more qualified buyers into homes.

Conventional mortgages can also be non-conforming, which means that they don’t meet Fannie Mae’s or Freddie Mac’s guidelines. One type of non-conforming conventional mortgage is a jumbo loan, which is a mortgage that exceeds conforming loan limits.

Because there are several different sets of guidelines that fall under the umbrella of “conventional loans,” there’s no single set of requirements for borrowers. However, in general, conventional loans have stricter credit requirements than government-backed loans like FHA loans. In most cases, you’ll need a credit score of at least 620 and a debt-to-income ratio of 50% or less.

Conventional Loan Requirements

It’s possible for first-time homebuyers to get a conventional mortgage with a down payment as low as 3%; however, the down payment requirement can vary based on your personal situation and the type of loan or property you’re getting:

• If you are not a first-time homebuyer or making not more than 80% of the median income in your area, the down payment requirement is 5%;

• If the home you are buying is not a single-family home (i.e. multi-unit) then you may need to put down 10% to 15%;

• If you are getting an ARM (Adjustable-Rate Mortgage) then the down payment requirement is 5%;

• If you are getting a Jumbo Loan then the down payment requirement ranges from 20% to 40%.

Private Mortgage Insurance

If you put less than 20% down on a conventional loan then you are required to pay for private mortgage insurance (PMI). PMI protects your lender in case you default on your loan. The cost for PMI varies based on your loan type, your credit score, and the size of your down payment.

PMI is usually paid as part of your monthly mortgage payment, but there are other ways to cover the cost as well. Some buyers pay it as an upfront fee. Others pay it in the form of a slightly higher interest rate. Choosing how to pay for PMI is a matter of running the numbers to figure out which option is the cheapest for you.

The nice thing about PMI is that it won’t be part of your loan forever – that is, you won’t have to refinance to get rid of it. When you reach 20% equity in the home on your regular mortgage payment schedule, you can ask your lender to remove the PMI from your mortgage payments.

If you reach 20% equity as a result of your home increasing in value, you can contact your lender for a new appraisal so they can use the new value to recalculate your PMI requirement. Once you reach 22% equity in the home, your lender will automatically remove PMI from your loan.

Credit Score

In most cases, borrowers will need a credit score of at least 620 to qualify for a conventional loan.

Debt-to-Income Ratio

Your debt-to-income ratio (DTI) is a percentage that represents how much of your monthly income goes to pay off debts. You can calculate your DTI by adding up the minimum monthly payments on all your debts (like student loans, auto loans and credit cards) and dividing it by your gross monthly income. For most conventional loans, your DTI must be 50% or lower.

Loan Size

For a conforming conventional loan, your loan must fall within the loan limits set by Fannie Mae and Freddie Mac. The loan limit changes annually. In 2020, the limit was $510,400. In 2021, it’s $548,250. There are exceptions, however. Alaska, Hawaii, and high-cost areas of the country have higher loan limits, ranging up to $822,375 for 2021. To see loan limits for your area, visit the Federal Housing Finance Agency website.

Summary

Conventional loans generally offer lower costs than other loan types, and if you meet credit score requirements and have a down payment of at least 3%, a conventional mortgage might be the best solution for you. We can help you decide if this is the best fit for your situation, give me a call or text at 425-224-5794 if you have any questions.