Conventional loans are loans not insured by FHA, VA, or UDSA. Before the mortgage crisis both Fannie Mae and Freddie Mac were private institutions that were publicly traded. After the government bail-out both organizations were taken into conservatorship by the government agency, the Federal Housing Finance Agency (FHFA). Although these institutions are now government backed or government–sponsored agencies (GSE’s), they still remain separate from the government itself.
More than half of new mortgages are conventional loans which includes special low down payment programs such as the Conventional 97 and HomeReady.
Conforming Loan Limits
Conventional loan have lending limits. As of 2016 the national limit for a conforming loan is $417,000. Most of the programs such as; FHA, VA and USDA have lending limits about the same or less than this amount. FHA and USDA may limit this amount further based on regional, county or city limits. High cost areas have higher lending limits. For example, Seattle, Washington has a maximum loan limit of $540,500 and Los Angeles, California has a loan limit of $625,500. Higher loan limits also apply to two, three and four family unit homes as well.
- 2,916 counties have loan limits of $417,000
- 115 counties have loam limits between $417,000 and $625,500
- 108 counties have loan limits higher than $625,500
- 4 counties in Hawaii have limits between $657,800 and $721,050
Some areas of Hawaii, Alaska, Guam and the Virgin Islands have a long-standing regulation that allow for loan limits to be higher than $721,050
If you need a mortgage larger than this conforming loan amount then you need a non-conforming jumbo loan instead of a conventional loan. Jumbo loans typically have higher down payment requirements (15% – 30%), require higher credit scores (700 or higher), require a debt to income of no more than 43% and require reserves of 6 to 12 months.
You would have to shop around to see what’s out there for jumbo loans. You could find a lender that will allow a down-payment of only 5% on a jumbo loan. For the purposes of this article, we will not go into jumbo loans, but rather stick to conforming conventional loans and programs.
Conventional Loan Fees and Requirements
Conventional lending fees can vary based on your credit worthiness, the loan program you use and the lender. The low down-payment conventional loans usually allow 100% of the down-payment (and closing costs) to come from certain individuals/organizations as a gift. Read this article on down-payment assistance for more information. Conventional loans have typical upfront costs and fees; earnest money, inspection(s), appraisal fees and home education classes if applicable. Conventional loans do not charge funding fees like VA loans but the lender might have a loan processing fee.
Debt to Income Ratios
The maximum debt to income ratio (DTI) for conventional loans is 31/43. However, certain programs allow for a borrower to have a DTI of up to 50%. Exceptions for high DTI include situations such as; high credit scores and/or a large cash reserves. Unlike FHA, there are more variations in conventional lending and therefore, it is much more important to talk to a knowledgeable mortgage broker or loan officer.
Your credit score is one of the biggest factors that can affect your Loan Level Price Adjustment (LLPA). The LLPA is risk-based fee assessed to the borrower based on credit and additional compensating factors which include; loan-to-value, occupancy type and units in a home. The LLPA’s add adjustments to the price of the loan, in other words, it determines the borrowers rate. The “riskier” the loan the higher the interest rate will be.
There are several risk characteristics that trigger “adjustments” and whichever of these characteristics gets triggered the borrower must pay in the form of an increased rate. LLPA’s only affect conventional loans, you can find more information on LLPA’s here.
Eligible Property Type
Eligible property for conventional properties include single family attached and detached homes, planned unit developments (PUD’s), one, two, three and four unit properties, condominiums*, some co-ops, and manufactured homes*.
*There are requirements the condo must meet, such as 51% owner-occupancy, adequate budgets for the association, 90% of units must be complete, etc.
*Not all lenders/convention loan programs offer financing for manufactured housing.
Conventional loans are also used for second homes and rental or income properties. These investment loans usually have different requirements for DTI, reserves and down payments.
Private Mortgage Insurance (PMI) is the Fannie Mae and Freddie Mac equivalent to FHA’s mortgage insurance premium (MIP). PMI is required for loans with less than 20% down-payment. Unlike FHA’s and USDA mortgage insurance, the cost can vary depending upon your credit score and down-payment amount; the higher your credit scores and down-payment, the lower your PMI cost. Your loan officer should shop for the best PMI rate for you.
Some lenders will offer mortgage programs that do not have mortgage insurance or offer “lender paid mortgage insurance”, typically these will have higher interest rates to account for the difference. Use this method if you plan on refinancing within a few years.
There are two other options for PMI coverage, 1. the single premium and 2. the monthly premium. Single premiums are paid as lump-sum at closing and active for the life of the loan. Use this method if you are keeping your loan and/or you expect property values to remain flat. This will result in a higher closing costs, but a lower monthly payment.
The monthly premium is the most common PMI payment option. The monthly option is the annual payment split over 12 months and added to your mortgage. Use this method if you plan on keeping the house and you expect the value to rise. You can cancel the mortgage insurance once the loan reaches 78- 80% of the value of the house. This will reduce your monthly payment once the mortgage insurance is cancelled.
Conventional loans also have a second advantage over FHA mortgage insurance. There is no Upfront Mortgage Insurance Premium (UMIP). The UMIP is 1.75% of your mortgage amount on a FHA loan which adds up to $1750 on a $100,000 mortgage. This is a cost you will not have to worry about if you use a conventional loan.
Warnings and Restrictions about Conventional Loans
Make sure you are getting the best loan for you. Conventional loans have many variations; regular 20%, 10%, 5%, and 3% down payment options like the Conventional 97 and HomeReady programs. If you speak with a loan officer that is unfamiliar or doesn’t offer several options of conventional loans you need to find another loan officer.
Mortgage Insurance is an extra cost added to your mortgage to protect the lender if you default on the loan. Mortgage insurance is usually charged if you do not put down 20% or more on a house. This 20% down to avoid mortgage insurance is usually why people think they need a 20% down payment to buy at all.
You can avoid mortgage insurance by paying this cost upfront, but regardless, once you have 20% equity in your loan, mortgage insurance is cancallable. You should make sure to keep up with this cost and the value of your home. The lender might not cancel the insurance on their own.
Why Conventional over FHA and NACA?
Conventional loans are the least frightening to sellers because they will likely not have inspection and/or appraisal issues like FHA or VA are prone to have. If a seller has the option of accepting a buyer with FHA or conventional financing – the conventional option will likely win with all other things being equal.
Although conventional loans require a higher score, they offer much more flexible options. While you will have to get mortgage insurance, there are options on how to handle paying mortgage insurance. And, you can cancel mortgage insurance once the loan reaches 78-80% of the home value.
Finally, conventional loans require fewer steps to close which is usually a win over FHA and definitely NACA. Yes, NACA loans are “conventional”, but they are still part of a special program that requires tedious effort and usually has delays at several points going through the program.
When you are home shopping you will notice some listings say “cash or conventional only” – this means you cannot submit an offer using FHA financing. If you really want to purchase that particular house, you will need to find a conventional lender.
Conventional 3% Down-Payment Loan Options
Fannie Mae and Freddie Mac now offer options for low down-payment loans that really compete with FHA’s 3.5% down loans. Conventional loans offer programs with as little as 3% down which is even lower than the FHA requirement of 3.5% down. Get a brief overview of the two products here.
HomeReady Purchase Options & Down-Payment
The HomeReady loan is available to borrowers who do not own a residential property. You must complete a home buyer education course online. The course is 4-6 hours long. This course has a fee which is typically about $75. This is paid upfront and out-of-pocket.
Eligibility requirements for the HomeReady program is 100% of area median income (AMI’s) and/or the home must be in a low-income census tracts. The low-income census tracks are in areas where the median household income is at least 20% below the average median household income for an area. Properties in FEMA disaster areas will also qualify for the HomeReady mortgage regardless of if the house/disaster area is in a low-income area.
There are no income limits on the HomeReady program as long as the house is in a low-income census track.
HomeReady Refinance Options
You can use the HomeReady to refinance your current home. You can refinance a home up to 95% LTV in some cases using the HomeReady program.
HomeReady permits “income pooling” which means the lender will count the income of anyone living in the household such as; in-laws, grandparents and even working children to help you qualify for the loan. The HomeReady loan only requires that the person(s) income pooling to live with you for the next 12 months. This person does not have to be a family member or have previously lived with you.
Any income level can use the HomeReady loan as long as the home being purchased is in a low-income census track area.
Debt to Income Ratio
The Maximum DTI for the HomeReady program is 50%
Homeready is open to borrowers with a 620 credit score and higher.
HomeReady has a lower than normal PMI cost than FHA and the Conventional 97 loan.
Eligible Property Types
Homeready can be used for single family loans, condominiums*, co-ops, manufactured housing*, and two, three and four unit homes.
95% LTV financing on manufactured housing and 7/1 and 10/1 ARMs only
HomeReady is available in 10, 15 20 and 30 year fixed rate loans and 5, 7 and 10 year adjustable rate mortgage (ARM’s) loans.
Fannie Mae offers the HomeReady program and is available from most US lenders. HomeReady allows for a down-payment as low as 3%, and the 3% down-payment can come in the form of a gift. The down-payment can also be “cash-on-hand” meaning it does not have to be in the bank.
Warning and Restrictions of HomeReady
To use the HomeReady program you must not own a residential property within the US. You can own property outside the United States or a commercial property.
The program is not restricted to first time buyers, but you must take a home ownership counseling course.
Conventional 97 Purchase Option & Down-Payment
Both Fannie Mae and Freddie Mac offers the Conventional 97 loan. Both allow buyers to purchase a home with a minimum of 3% down-payment. The price of the home cannot exceed the national conforming limit of $417,000 or $625,000 in high cost areas. Unlike the HomeReady program, a home ownership program is not necessary.
Conventional 97 Refinance Options
You can refinance other Fannie Mae mortgage loans with the Conventional 97 program. If you are unsure if you have a Fannie Mae loan use the lookup tool here to determine the servicer.
There are no income limits to this program.
Debt to Income Ratio
Your maximum DTI for the Conventional 97 program is 43%.
Per the Fannie Mae and Freddie Mac Loan Level Price Adjustment guidelines, you only need a credit score of 620 to qualify for the Conventional 97 loan. There is a slight rate increase because of the low down payment. However, the increase minor compared to the added benefit of only having to put 3% down. There is a chance you can receive the same (or lower) rate as borrowers that put 20% down. This usually occurs because the mortgage insurance on the 3% down-payment loans takes some of the risk off Fannie Mae/Freddie Mac and the lender.
Some lenders may require higher credit scores so shop around for the right lender.
PMI is requirements for this loan and will vary based on your credit. The lower your credit score, the more PMI will cost. PMI can range from $75 to $125 per $100,000 borrowed.
Eligible Property Types
Qualifying property types are condominiums*, one unit single family detached and attached homes (town home), and co-ops.
Condos must pass certification process
Manufactured homes and two, three and four unit homes are not permitted under the Conventional 97 loan.
The Conventional 97 program requires a fixed rate mortgage of 10, 15, 20 or 30 years. This program does not permit adjustable rate mortgages (ARM’s).
You must put a minimum of 3% down on the purchase of the home. You can use 100% gift funds for the down-payment and closing cost . The gift funds must come from a family member or government organizations that provide down payment assistance. See a list of first time buyer programs here.
Warning and Restrictions of Conventional 97
You must be a first time buyer to use this program, meaning you have not owned a house within the last three (3) years. The home purchased under this program must be a primary residence.