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Conventional Mortgage Loans

A conventional loan is any mortgage that is not guaranteed or insured by the federal government like FHA, VA or USDA loans. Conventional loans may be either "conforming" or "non-conforming". Conforming loans follow the terms and conditions set by Fannie Mae and Freddie Mac which are "government-sponsored enterprises" (GSEs). This means that they are privately owned, but receive support from the Federal Government, and assume some public responsibilities. The primary function of Fannie Mae and Freddie Mac is to provide liquidity to the nation’s mortgage finance system. About half of all conventional loans are called "conforming" mortgages because they conform to guidelines established by Fannie Mae and Freddie Mac.


Loans that do not conform to GSE guidelines are referred to as "non-conforming" home loans. Non-conforming loans that are larger than loan limits set by the GSEs are often referred to as "jumbo" mortgages. All nonconforming mortgages are also conventional mortgages.


Another type of conventional mortgage is portfolio loans offered by portfolio mortgage lenders. These types of loans are held by mortgage lenders on their own books. Because lenders can set their own guidelines for these loans, their loan products may have features that other mortgages do not. They are also able to offer more flexibility in loan products and loan programs because they don’t need to adhere to the guidelines of secondary market buyers. That means unique program guidelines and special offerings that other banks can’t offer.


Subprime mortgages are also considered conventional mortgages. These loan products are marketed to borrowers with low credit scores. They typically come with high-interest rates and fees. The government has created special rules covering the sale of such products, but they are not government-backed.


Conventional Loan Highlights-

  • You can use a conventional loan to buy a primary residence, second home, or rental property

  • Conventional loans are available in fixed rates, adjustable rates (ARMs), and offer many loan terms usually from 10 to 30 years.

  • Down payments as low as 3%

  • No monthly mortgage insurance with a down payment of at least 20%.

  • Lower mortgage insurance costs than FHA.

  • Mortgage insurance can be canceled when home equity reaches 20%, unlike FHA loans which require insurance during the entire term of the loan.


Conventional Loans And Second Mortgages
There are a number of programs now being offered to homebuyers. Below are a few of the most popular and up and coming programs available.


The Conventional 97
Home buying just got a lot easier. Fannie Mae and Freddie Mac now allow home purchases with just a 3% down payment. The 97% loan-to-value (LTV) purchase program allows homebuyers to purchase a single family home, condo, co-op, or PUD without coming up with a full 5% down payment as previous guidelines mandated. Now just a 3% down payment is needed. That’s even lower than the FHA requires.

The HomeReady™ Mortgage
HomeReady™ is a mortgage program created in December 2015. It's backed by the U.S. government thru Fannie Mae and its approved lenders. HomeReady™ allows a down payment of just 3% on a home and permits the "income pooling" for all of the members of a household. This means that income from grandparents, parents, relatives, and working children can all be used to help qualify for a home loan even if they are not officially on the loan file. Also, with HomeReady™, households in lower-income neighborhoods and in minority-heavy areas can get easier access to low-down payment mortgages at today's current rates. 


The drawback to this 3 % down loan programs is that the interest rate may be higher to compensate for the smaller down payment. Mortgage insurance may be more expensive as well, compared to a 5% or 10% down conventional loan.


Piggyback Mortgages & The 80/10/10
A piggyback loan is actually two mortgage loans. The first loan is a mortgage for the majority of your borrowed amount, and the second loan is a mortgage for what remains. The loan is known as a piggyback mortgage because the second mortgage is metaphorically "piggybacking" on the first, combining to make a loan size for the total amount an applicant wants to borrow. Piggyback loans are generally available up to 90% loan-to-value (LTV) on the purchase price, with the first lien typically comprising 80% of the price, and the second "piggyback" mortgage comprising 10% of it. This particular structure is known as an 80/10/10.


When you read "80/10/10", the "80" represents the LTV of the first mortgage; the "10" represents the LTV of the second mortgage; and, the last "10" represents the down payment which the borrower makes on its own. With piggyback loans, most often, the 80% portion is a 30-year fixed rate mortgage and the 10% portion is a home equity line of credit (HELOC).


Piggyback Mortgages & The 75/15/10

Another typical piggyback structure is the 75/15/10. The first lien is for 75% of the purchase price, the second lien is for 15% of the purchase price, and the remaining 10% is the borrower's down payment on the home. It's common to see the 75/15/10 used in conjunction with the purchase of a condominium. This is because mortgage rates for condos are higher when the LTV of the first lien exceeds 75%. To avoid paying higher rates condo buyers will limit their first lien size to seventy-five percent. The remaining fifteen percent is handled by the home equity line of credit (HELOC).


Other buyers will use piggyback loans because they're buying a home which exceeds their local mortgage loan limits. Using the piggyback loan will allow them to borrow up to $417,000 on their first lien, and then borrow the additional amount required for a second loan.


Offer Letter Mortgage Loans
This special program is known as the Offer Letter mortgage. U.S. lenders are now making loans based on the "future income" of a borrower’s next job, and will even approve a loan based on a pay raise they have coming at work. For recent university graduates and employees relocating to a new town, the Offer Letter mortgage helps to simplify homeownership.


Conventional Loan Limits
Currently, the conventional loan limit for is $417,000. However, Fannie Mae and Freddie Mac have designated high-cost areas where limits are higher.


Properties Eligible For Conventional Financing

Many types of properties are eligible for conventional financing. These are:

  • Single family homes (Detached homes)

  • PUDs, or Planned Unit Developments which typically consist of detached homes within a homeowner’s association.

  • 2-,3 and 4-unit properties

  • Condominiums

  • Some co-op properties

  • Manufactured homes (although few lenders offer this program)


Second Homes And Investment/Rental Properties
Unlike government loan programs, conventional loans can be used to purchase a second home or a rental. Interest rates and down payment requirements are higher when financing a rental home, but the conventional loan remains one of the few programs available to purchase this kind of property.


Conventional Conforming Loan Requirements
Getting approved for a conventional loan is pretty much the same as government-backed loans like FHA. The borrower needs to prove they make enough money, that their income is expected to continue, they have enough assets to cover the down payment, plus an adequate credit history and a decent credit score.


Many people are under the mistaken belief that a conventional loan is hard to qualify for but this is not the case. Conventional loans do not come with an implicit government guarantee that repays the lender if the buyer fails to do so. Therefore, it's a higher risk involved so higher standards from the lender are required. However, conventional loan qualification is not difficult for the average home buyer.


Generally speaking, conventional loans are best suited for those with a credit score of 680 and above. Applicants with lower scores can still qualify, but their costs may be lower with other loan programs like FHA. The minimum accepted score for most conventional loans is 620. Conventional loan rates are heavily based on credit scores more so than rates for the FHA loans. Fannie Mae and Freddie Mac publish Loan Level Price Adjustments, which increase interest rates for lower credit score buyers. For example, a home buyer with a 740 score and 20% down will be offered about 0.50% lower rate than a buyer with a 640 score. 


Conventional Loans And Recent Bankruptcy

It’s possible to be approved for a conventional loan after a bankruptcy. However, there are waiting periods and applicants must demonstrate that they’ve re-established their credit. According to Fannie Mae’s guidelines, the waiting periods required after bankruptcy are as follows:


• Chapter 7 or Chapter 11 Bankruptcy:

A four-year waiting period, measured from the discharge or dismissal date is required. A waiting period of two years is possible if extenuating circumstances can be documented, such as job loss that is not expected to recur.


• Chapter 13 Bankruptcy:

Two years from the discharge date or four years from the dismissal date.


A bankruptcy is never a good thing on your credit report, but it doesn’t necessarily disqualify an applicant from ever getting another mortgage.


Income And Asset Documentation

Most lenders require a two-year documentation to show consistent earnings. Applicants need to provide documents proving their income and assets, just like with most other loan types. Here’s a list of some of the things you will need:

  • 2 months of bank statements – (all pages)

  • 1 month of pay stubs

  • 2 years of tax returns if self-employed or have rental properties or non-salary income - (if applicable)

  • W2s - 2 years

  • Social security, retirement, and/or pension award letters and/or 2 years’ 1099s - (if applicable)

  • Rental agreements for any investment properties currently owned - (if applicable)

Other Income Sources
Alimony can also be counted if documented in a divorce decree, along with the recurring method of payment such as an automatic deposit. Seasonal income is also accepted, again with proof in a tax return.


Down Payment
The amount of the borrower's down payment can affect the interest rate and final loan costs. Putting down a larger amount means that the monthly mortgage costs will be less. A payment of at least 20% down will eliminate mortgage insurance, a requirement of the FHA and USDA loans even with a large down payment. A conventional loan borrower has the option to put anywhere from 3% to 20 % down or more.


Down Payment Gifts
A down payment gift can cover the entire amount down in some cases. Check with the lender for gift and donor documentation requirements. Without a gift, the applicant will need to verify a valid source of the down payment such as a savings or checking account. Applicants can also liquidate investment accounts and even use a 401k loan for the down payment. Typically, home buyers will need to supply a 60-day history for any account from which down payment funds are taken.

Conventional Loan Debt-to-Income Ratios
Usually the maximum debt-to-income ratio (DTI) for a conventional loan is 43%. However, exceptions can be made for DTIs as high as 50% with strong compensating factors like high credit and/or lots of cash reserves. If a borrower has dings on their credit or don’t have a lot of cash reserves, their maximum DTI may need to be much lower than 43%.


Property Appraisal
The lender will require an appraisal that values the house at the selling price. Conventional loans come with less strict appraisal and property requirements than do FHA, VA or USDA loans. This means borrowers can qualify for a home in slightly worse condition and plan to make the repairs after their loan is approved and they move in.


Private Mortgage Insurance (PMI)
PMI is required any time you put less than 20% down on a conventional loan. For those with good credit, private mortgage insurance on conventional loans can cost less than FHA’s mortgage insurance. This is because PMI is risk-based insurance, meaning that the better the borrower’s credit history, the lower the premiums.


These are the basic requirements for most conventional loans. However, lenders have different requirements and offers which is why it’s best to shop around for a mortgage with at least 3 lenders.


Conventional loans are a great option for today’s home buyer. They offer great rates and low fees.


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