When buying a new home, there are plenty of options of ways to make that big purchase. Most people won’t have the cash to pay the entire home purchase amount, so instead, they may choose to borrow money through a mortgage or home loan.
Conventional loans are backed by financial institutions and usually have a down payment requirement.
Conventional loans can have low interest rates; they usually require less paperwork and often can be obtained more quickly than a government loan. They’re best suited for buyers who have:
• Great credit: To qualify for a conventional loan, your credit score should be 620 at minimum. The higher your credit score, the higher the probability of a better rate.
• Low debt-to-income ratio: You can calculate your debt-to-income ratio by adding all your monthly debt payments divided by monthly income before taxes. The debt-to-income ratio should be below 45% to qualify for a conventional loan.
• Down payment: While the minimum down payment is 3% with a conventional loan, more is preferred.
While other factors might be part of your decision, these are the main ones that can help determine if a conventional loan is a right option.
The down payment is a percentage of a home’s purchase price that is used to pay for the home. The down payment amount is then deducted from the cost of the house, and the remainder is the amount of loan or mortgage that’s required.
The minimum down payment varies depending upon the type of home and your purchasing situation. It will also vary depending upon your credit score and debt-to-income ratio.
For a conventional loan, the absolute minimum down payment required is 3%, and that home must be a primary residence and for a first-time homebuyer. In addition, the purchase price must be $548,250 or less to qualify for a 3% down payment.
For anyone not a first-time buyer, and it’s for your primary residence, a minimum amount of 5% is required.
If the home you’re buying is a second home, then you’ll need a down payment of at least 10%.
And if the home is not a single-family home or has more than one unit, you will need to put 15% down.
Any down payment below 20% also requires PMI, also known as private mortgage insurance. This PMI is necessary because the loan is considered a more significant risk to the lender. PMI can cost between .5% or 1% of the mortgage and is always rolled into the monthly mortgage payment.
Once you’ve paid enough of the mortgage principal, the PMI can be dropped. The drop happens when the principal mortgage balance is 80% of the home’s original value, which means that you have 20% equity in your home. At that point, you can request that the lender remove PMI from the loan.
It may automatically be removed when your mortgage balance is 78% of the home’s original value, or you’ve reached 22% equity in your home.
Conventional loans are typically split into two types: conforming and non-conforming. Fannie Mae and Freddie Mac are the two most prominent entities in the U.S. that are responsible for mortgages.
They are government-sponsored businesses that purchase mortgages from lenders and set specific guidelines for lenders to follow.
Conforming loans must meet guidelines set by Fannie Mae and Freddie Mac. Policies include credit score, down payment amount and income requirements, and loan limits.
A non-conforming conventional loan doesn’t have a loan limit. It’s also known as a jumbo loan. This type of loan would be backed by a private investor or financial institution instead.
Fixed-rate conventional loans keep the interest rate the same no matter how long you have your mortgage.
These loans can be up to 30 years long, meaning that the interest rate is locked in for the entire 30 years of the mortgage. When interest rates are low, this is the best option when making a home purchase.
Fixed-rate loans could also be acquired for 10, 15, or 20 years. The shorter-term of the loan, the lower the interest rate will most likely be. However, a shorter term will reflect a higher monthly payment than a 30-year mortgage.
Another option is an adjustable-rate mortgage, in which case the rate fluctuates over time. These ARMs usually have a fixed rate for the first 5 to 10 years. The rate will rise or fall along with federal interest rates after the predetermined time of three, five, seven, or ten years. This could be a good option if a home buyer is going to live in the home for a shorter period of time and the interest rates are fairly high.
Many home purchasers can get low interest rates with a conventional loan provided they have good credit and can make a solid down payment. The entire process is also usually quicker with a conventional loan, and there aren’t the same restrictions on the type of home that can be purchased that might be encountered with a government-backed loan.
Going with a conventional loan offers more flexibility in the home that you want to buy. You’re not restricted to a home that requires few repairs or one that is going to be used as a secondary home or rental property.
You’ll also want to ensure that you can qualify for a conventional loan based on the debt-to-income ratio, credit score, and down payment available.
In the long run, a conventional loan may save you money and time if you’re in a good financial situation. You’ll need to explore your finances and options before making a decision and determine which loan is the right choice and the most affordable one.