Often known as “conforming loans,” traditional loans “conform” to a set of Fannie Mae and Freddie Mac requirements. Conventional loans promise high prices, lower costs and versatility in homebuying. So, it is no surprise that it is the preferred loan option for more than 60 percent of all applicants for mortgages.
Conventional Lending Program Highlights:
- May be used to buy a primary house, second home or lease land
- Adjustable rates (ARMs) are available in fixed rates with loan terms from 10 to 30 years
- Payments down as little as 3 per cent
- No monthly private mortgage insurance (PMI) with at least 20 per cent down payment
- Costs for home insurance premiums lower than FHA
- Mortgage insurance will be discontinued until home equity exceeds 20 per cent (unlike FHA, which in most cases lasts the life of the loan)
Conventional Loan Prerequisites for 2020
Hypothecary down payment
Keep in mind that, the lower your overall loan costs, the more you put down. Your down payment amount helps to determine your PMI rate and interest rate, which will affect your monthly payment amount and total interest costs.
Bottom line: The higher your down payment, the less you spend on the loan monthly and throughout its life.
You may also use gift funds from a donor or qualified non-profit organization to pay for all of your down payment and closing costs for the loan. Get more information about the gift funds here.
What is the minimum required down payment for a conventional loan?
Conventional loans need as little as 3 per cent down (even lower than loans from FHA). However, private mortgage insurance (PMI) is provided for down payments of less than 20 per cent. (PMI can be withdrawn after earning 20 per cent of the equity in the home.)
|Scenario 2||Scenario 3|
|Down payment %||20%||10%||5%|
|Total interest + PMI over 5 years||$30,548||$38,866||$43,211|
* Assumes a credit score of 720–739.
Insurance on Private Mortgages (PMI)
PMI is needed if a traditional loan is put down to less than 20 per cent. However, unlike FHA mortgage insurance, which is required for the life of the loan, it can be withdrawn in most cases once you hit 20 per cent equity in your house.
Private mortgage insurance for those with good credit can cost less than FHA mortgage insurance on conventional loans. Why? For what? PMI, like auto insurance, is risk-based insurance which means the better your credit history, the lower your premiums. If you have a clean history, you benefit.
Each private mortgage insurance firm has varying rates for different scenarios of down payment and credit score. Make sure your lender shops around will cost you the best PMI.
See our post that compares FHA to conventional 97 loan for an in-depth comparison of PMI and FHA mortgage insurance.
Can a second mortgage do away with PMI?
The piggyback mortgage, also called the 80-10-10 or 80-5-15 mortgage, is a loan option which is growing in popularity.
This loan arrangement uses a traditional loan as the first mortgage (80% of the purchase price), a reciprocal second mortgage (10% of the purchase price), and a 10% down payment from the homebuyer. The combination of both loans can help you avoid PMI, since the lender regards the second loan as part of your down payment.
For a closer look at these loans, see our blog post on the piggyback loan.
Standard credit scores
Conventional loans are generally best suited for those with a credit score of 680 or above. Applicants with lower scores may still qualify but with other loan programs, the associated costs may be lower. Fannie Mae and Freddie Mac, for example, impose Loan Level Price Adjustments (LLPA) on lenders who then pass those costs on to the consumer. This fee would cost your credit score more.
For example, anyone with a score of 740 putting 20 per cent down on a home has added 0.25 per cent to their loan fee. But, somebody with a score of 660 putting down the same amount would add a fee of 2.75 per cent. Show the complete matrix of LLPAs.
Ratios Modern debt-to – income loan (DTI)
For a traditional loan, the average debt-to – income ratio (DTI) is 45%. For good compensating factors such as a high credit score and/or plenty of cash reserves, exceptions may be made for DTIs as high as 50 per cent.
If you have dings on your credit or you don’t have a lot of cash reserves, your maximum DTI may be well below 45%. In general, the lower your DTI, the greater your lending approval chances.
The best way to check your debt-to – income level for the maximum home price is to get a pre-approval from a conventional lender.
Income and Documentation of Assets
Like most other types of loans, you’ll have to provide documentation to prove your income and assets. Here’s a list of some of the required documentation:
- 60 Days bank declarations (all pages)
- 30 Days of pay stubs
- Two-year tax returns if self-employed, leased, or non-salary income (retirement, pension, etc.).
- W2 2 Years
- Letters of Social Security, Retreat and/or Pension Award, and 2 years 1099
- Rent agreements for any currently owned investment properties
Conventional debts and recent bankruptcies
After a bankruptcy you can be approved for a conventional loan. Nonetheless, there are waiting periods that are needed and you must prove that you have regained your credit.
Required post bankruptcy waiting periods:
Chapter 7 or Chapter 11: It needs a waiting period of four years, calculated from the date of discharge or dismissal. A two-year waiting period is possible if extenuating circumstances, such as work losses which are not expected to recur, can be reported.
Chapter 13: 2 years from the date of discharge, or 4 years from the date of discharge. In extenuating situations a two-year probation period from the date of the dismissal is likely.
A bankruptcy on your credit report is never a positive thing, but it doesn’t automatically disqualify you from ever having another mortgage.
Coordinated Loan Guidelines 2020
Limits to conventional loans by 2020
For a single family home the traditional loan cap for 2020 is $510,400. Yet Fannie Mae and Freddie Mac have identified high-cost areas with higher limits. A single-family home in Seattle , Washington for example, may have a maximum loan of $592,250. The same home located in Los Angeles, California will be liable up to $636,150 for a loan sum.
There is also an rise in loan amounts for 2-, 3-, and 4-unit dwellings. Loan limits are also higher for multi unit homes situated in high-cost areas. A 4-unit home in Honolulu , Hawaii, for example, can be funded at up to $1.2 million.
Standard Caps for traditional loans:
- 1-unit home: $510,400
- 2-unit home: $653,550
- 3-unit home: $789,950
- 4-unit home: $981,700
The assets qualify for traditional financing
- Single-family homes (family homes)
- Planned development of units (PUDs), typically consisting of detached houses within a homeowner’s association
- Properties: 2-, 3-, and 4-unit
- Some cooperative properties
- Fabricated homes (though this program is offered by few lenders)
Onventional Condominium Loans
Many condo projects throughout the country qualify for conventional financing. However, there are certain specific guidelines which need to be met. There may be several more provisions for newly constructed or converted condo projects. If you are unsure if the unit you are interested in in in a condo project follows these requirements, ask your real estate agent or loan officer.
Here are some of the traditional credit requirements that a condo must meet in order to qualify:
- The unit owners or HOA must complete and own all common areas
- At least 51 percent of the project’s total units will be occupied by owners or second homes
- The HOA needs to have a clear budget
- At least 90 percent of units will be sold and owned by unit owners at present (existing projects)
- No single person can own more than 10 per cent of the project’s units
- Insurance must protect the project adequately
Second homes, and properties for investment / rent
In contrast to government loan programs, conventional loans may be used to buy a second home or rental property. Interest rates and down payment expectations are higher when purchasing a rental property, but one of the few lending services available for buying rental properties remains the traditional lending.
I am ready to claim a conventional loan
Conventional lending is a perfect choice for homebuyers today. They are offering superb rates and low fees. Down payment thresholds are as small as 3%, and private mortgage insurance (PMI) will be discontinued if home equity exceeds 20%.