First-Time Homebuyer 101: Everything You Need to Know About Conventional Loans
When it comes to financing a home purchase, prospective buyers often find themselves navigating through a myriad of loan options. Among the various choices available, conventional loans stand out as a popular and versatile financing solution. As a cornerstone of the mortgage industry, conventional loans offer borrowers flexibility, competitive interest rates, and a straightforward application process. Whether you’re a first-time homebuyer or a seasoned real estate investor, understanding the nuances of conventional loans is essential for making sound financial choices in the realm of homeownership.
What is a Conventional Mortgage?All mortgages can fall into one of two specific categories: “conventional” mortgages and “non-conventional” mortgages. While both types of mortgages have the same basic goal—helping people become homeowners—the differences between these types of mortgages are important to keep in mind. Whether you want to secure a conventional or non-conventional mortgage will have a major impact on the mortgage application process.
Generally speaking, the primary difference between conventional and non-conventional mortgages is that conventional mortgages are backed by a private lender (your mortgage provider), while non-conventional mortgages are backed by the federal government. Currently, the majority of mortgages in the United States are categorized as conventional mortgages.
Because conventional mortgages are backed by private (for-profit) organizations, applicants will usually need to meet a basic set of mortgage standards. The most common type of conventional mortgage is a conventional conforming mortgage, which means you will usually need to apply for a mortgage amount that is less than $766,550 (if you live in the 48 contiguous states) and you will need to meet some basic credit score standards—typically, 620 or higher. You’ll also usually be required to make a down payment of at least 3 percent before you can close (and pay for private mortgage insurance if your down payment is less than 20 percent), however, there are many exceptions to the rules mentioned above.
In addition to the very common conventional conforming mortgage, there are several other types of conventional mortgages available as well. For example, a non-conforming jumbo mortgage can be used to secure a home above the conventional loan size limits (which we discuss later on in this article), though you will typically be expected to make a proportionately larger down payment. Non-owner occupied mortgages are available for people, such as landlords, hoping to purchase a home that will not use as their primary residency. And alternative mortgage programs are available for people who have low credit scores or have a non-traditional credit profile.
Regardless, what all conventional mortgages have in common is that they are not issued by the government but are issued by private entities. Though the government might regulate these mortgages, the risk is held by the lenders who, therefore, get to set the standards for the mortgage application process.
What do I need to qualify for a Conventional Loan?
Securing a conventional loan for buying a home is more achievable than you might think. In fact, approximately 70% of all mortgages in the U.S. are conventional loans, demonstrating their widespread acceptance. While these loans generally have higher qualification standards compared to government-backed alternatives, meeting the criteria is attainable for most homebuyers.
To qualify for a conventional loan, you typically need:
- A good credit history and a credit score of 620 or higher.
- A minimum down payment of 5% (or 3% for specific niche programs).
- Steady income to cover monthly payments.
However, if you face challenges such as a less-than-stellar credit history, lower income, or limited savings, you might explore government-backed mortgages that offer more flexibility and relaxed eligibility criteria.
Outside of the basics outlined above, there are many other important factors of which to be aware. These additional requirements, like the three detailed below, will play a large part in your loan approval and interest rate, so it’s important to do your research and see how these considerations will impact your ability to secure a home loan.
Private Mortgage Insurance (PMI): PMI becomes mandatory when the down payment falls below 20%, acting as a safeguard for mortgage investors in case of default. The cost of PMI varies, influenced by factors such as loan type, credit score, and down payment size. Borrowers may be able to opt for various payment structures, including monthly installments, upfront fees, or a slightly elevated interest rate. However, once borrowers attain 20% equity through regular payments or an increase in the home’s value, they can request the removal of PMI, offering a tangible incentive for diligent repayment.
Debt-To-Income Ratio (DTI): Debt-To-Income Ratio (DTI) is a crucial metric that assesses the percentage of monthly income allocated to debt payments. While conventional loans generally permit a DTI of up to 50%, having a lower DTI significantly enhances the likelihood of loan approval. Lenders view a lower DTI as indicative of a borrower’s stronger financial position and capacity to manage additional debt responsibly.
Loan Size Limits: Conforming conventional loans must align with the loan limits set by Fannie Mae and Freddie Mac. For the year 2023, the conforming loan limit for a single-family home stands at $766,550, although exceptions exist for high-cost areas, such as Alaska and Hawaii, where limits can be higher, reaching up to $1,149,825. Borrowers should verify the loan limits applicable to their specific location, which can be found on the Federal Housing Finance Agency website.
As you explore home financing options, conventional loans emerge as a versatile and widely accepted choice. Whether you’re new to homeownership or an experienced investor, understanding the basics of conventional mortgages is key. This understanding will pave the way for a smoother and more informed journey towards securing your dream home.