Conventional Loans
Conventional Mortgage Loans
Conventional Mortgage Loans
Looking to expand your real estate portfolio? Perhaps you have a short-term vacation rental already lined up. As all new and seasoned investors know, the perfect investment property always starts with the right mortgage.
But choosing a mortgage that suits your investment goals and financial credentials isn’t always easy. If you qualify for a conventional loan, it may be the vehicle that carries you into the investment property of your dreams. But as loan providers increase the benchmarks on conventional mortgage qualification standards, more investors seek to learn more so they can determine whether this option is the best for their goals.
In this article, we’re going to dive into conventional
home loans so you can discover for yourself whether
they are right for you.
What Are Conventional Loans?
A conventional home loan is any residential property mortgage that is not secured by a federal government entity. Instead, conventional mortgages are backed by private institutions such as banks, credit unions, or mortgage lenders. They offer greater flexibility to homebuyers, though come with more stringent credit guidelines than their government-backed counterparts.
Conventional mortgages gained substantial popularity following the Great Depression, as oppressive qualification measurements barred many people from being able to purchase real estate. In response, the federal government started the Federal National Mortgage Association (or the FNMA, also known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac) to counter the low homeownership rates.
Fannie Mae and Freddie Mac
With improved mortgage terms and increased accessibility, homeownership financing challenges were alleviated and more people became empowered to enter the real estate market. Today conventional loans make up the majority of mortgages in the U.S. mortgage market. As we’re going to discuss, there are many variations on conventional loans, including some that comply with Fannie and Freddie and those that bypass conventional mortgage limitations.
The Mortgage Shop, LLC is a conventional mortgage provider offering alternative loan options for individuals who want to invest in property on their terms. If you are looking for innovative investment property mortgage solutions to suit your financial goals, contact The Mortgage Shop, LLC today.
What are the Types of Conventional Loans?
If you are considering taking out a conventional mortgage loan, there are a few different types to choose from. The market of conventional loans is complex, and loans can be grouped in various ways, depending on the measures you look at. Most commonly, investors refer to the difference between conforming loans and non-conforming loans.
Conforming mortgages are those that meet the guidelines set by Fannie Mae and Freddie Mac. In the market, conventional loans are pooled together and sold to investors as shares, meaning homebuyers have a steady supply of mortgage money. Conforming loans usually have lower interest rates than non-conforming loans, because the lender is not taking on all of the risk.
The conforming loan guidelines include restrictions on how much you can borrow, what your debt-to-income ratio is, and which credit scores are acceptable.
A jumbo loan is a type of mortgage loan that is higher than the conforming loan limit set by Fannie and Freddie. Jumbo loans may be harder to qualify for and can come with higher interest rates than other types of loans.
With that in mind, the right mortgage provider can offer excellent benefits with jumbo loans that effectively facilitate the purchase of a property you really desire, when a conforming loan cannot finance it. For example, The Mortgage Shop offers accessible down payment options that empowers property buyers to make financial decisions that will serve them over the long term, such as:
- 3.5% down for primary residences
- 10% down for a second home
- 15% down for an investment property (up to $647,200 loan value)
There is a broad range of loans now available to investors that do not strictly conform to Fannie Mae and Freddie Mac's guidelines. This includes jumbo loans but also extends to a range of other nominations.
For example, conforming mortgages require that an investor produce tax returns or pay stubs to qualify. A non-conforming loan lender may instead choose to review average bank deposits over a set period of years or the profitability of an investment property to determine an investor's eligibility.
A non-conforming mortgage can help finance individuals with low credit scores. These are known as non-prime loans. They also include unconventional property types such as condos or farms.
A portfolio loan is a type of mortgage that is not backed by the government or by Freddie Mac and Fannie Mae. Instead, the loan is backed by the lender. This allows lenders to provide creative mortgage products to investors and design their programs as they please. Because the lender absorbs all risk associated with the loan, it will usually hold a higher interest rate than other loan classifications.
Non-traditional financing has become more popular in recent years because it provides an excellent alternative for individuals who don't fit neatly into conventional options. These people may be self-employed or investors who want to fund their mortgage with rental income. If you are looking for a mortgage provider with brilliant solutions that can meet your financing needs, speak with The Mortgage Shop.
How Can I Qualify for a Conventional Loan?
Individuals with an established credit history, stable employment, and impeccable financial records can usually qualify for a conventional conforming loan. Non-conforming conventional loan qualifications vary depending on the specific standards set by each lender.
More specifically, individuals who want to attain a conventional loan should consider:
Down Payment
A minimum down payment of 20% of the property’s purchase price should be available. Many lenders accept lower down payments – some as low as 3% – on the condition that the borrower takes out private mortgage insurance (PMI). This assurance protects the lender if you default on your loan.
Paying for private insurance on the mortgage value can substantially increase monthly mortgage payments and the amount paid on the loan over the long term. However, most lenders only require PMI to be in place until the investor owns at least 20% equity in their property.
Credit Score
A credit score is a three-digit number determined by your financial history, including the number of late payments made to past or current financial obligations. This number indicates a borrower’s ability to pay back a loan.
A credit score of 620 or above is usually enough to qualify for a conventional loan, though in some cases it may be higher. In general, if a person has a high credit score they can get a lower interest rate on their loan, which could save thousands over the long term.
On the other hand, a lower credit score may land above the issuer’s qualification benchmarks, but the lender may charge greater interest to cover the increased risk.
Employment and Income
When you apply for a mortgage, you need to produce proof of earnings. To lenders, stable employment demonstrates your ongoing ability to pay back the loan amount. Many will ask for documents dating back at least two years.
For many investors, this has become an issue during the economic uncertainty of the pandemic. Accordingly, they may turn to non-conforming mortgages that offer greater flexibility around employment and income verification.
Your issuer may ask for some or all of the following documents:
- 30 days of pay stubs
- Two years of W2s
- Two years of tax returns for the self-employed
- An offer of employment letter, if you are waiting to start a
new job - Graduation documentation for recent graduates
Property Requirements
Lenders will not approve a loan amount that exceeds the value of the home. They will get an appraisal done on the home to determine the property’s fair market value before they close on the loan. This may trip up individuals who have agreed to pay a certain price before the home has been appraised and their loan approved.
For example, let’s say Johnny agrees to pay $300,000 for a home, but the appraisal determines the property’s worth as $285,000. The lender will only issue a home loan amount of $285k. Johnny may choose to use the lender’s limitations as a bargaining tool to get a lower price on the home, or he may have to pony up an additional $15k in his down payment to balance the loan amount.
Conventional Loan Limits
If you’re applying for a conforming conventional loan, your loan amount must fall within the limits set by Fannie Mae and Freddie Mac. This amount is adjusted annually. In 2022, the conventional loan limit is $647,200 which is the maximum loan amount conforming conventional loans can be.
There are exceptions to this regulation. For example, Alaska, Hawaii, and other high-cost regions across the country may have higher allowances. If your property is not located in an area with exceptions to this regulation, you will need to apply for a jumbo loan or another non-conventional loan.
Debt to Income Ratio
Your debt to income ratio (DTI) is a factor that determines what percentage of your income goes towards paying off your debt obligations, such as credit card repayments or student loans. It is calculated using the following formula:
Debt to Income Ratio
For example, Susie is an insurance broker who earns $4000 each month before tax. She makes monthly payments of $350 to pay off her car and $150 towards her student loan. Let’s plug in the numbers:
500 (350 + 150) / 4000 = 0.125 = 12.5%
Susie’s DTI, or the percentage of her gross income that goes towards paying off debt, is 12.5%. Most lenders want borrowers to maintain a DTI that is below 36% after their monthly mortgage payments have been factored into their total debt amount.
Closing Costs
Closing costs include several fees, such as your lender’s origination fee as well as vendor fees for the appraisal, title transfer, and credit report fees. A lender or seller may cover a portion of these costs, or the entirety of them depending on their desire to close the transaction.
You can check whether your issuer offers lender credit options and that they comply with Fannie and Freddie. For a rental or investment property, sellers can only cover closing costs up to 2% of the property’s sale price.
Who May Not Qualify for a Conventional Loan?
Some people do not qualify for a conventional loan through no fault of their own. Others may have come into financial hardship and cannot qualify. However, many barriers to qualification can be overcome with rigid personal financial practices and perhaps a little time.
Those who are young and do not have much financial experience, individuals with higher than average debt, or those with a modest credit rating may find it harder to qualify for a conventional loan. In particular, mortgages may be difficult to attain for people who have:
- Endured foreclosure or bankruptcy in the past seven
years - Credit scores below 620
- A DTI ratio above 43%
- Under 20% of the property’s purchase price available for the down payment
If you are turned down for a mortgage, ask the lender for their justification in writing. You may be able to use this to qualify for other home financing options, which we will discuss later.
What Advantages do Conventional Loans Offer?
Conventional loans offer borrowers a wider range of flexibility than their government-backed alternatives. Between the divergence of traditional employment entering modern culture and recent global events that have impacted the way people live and manage their finances, conventional loans serve an increasingly diverse market.
Here are a few advantages to taking out a conventional loan.
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Flexible Repayment Options
With conventional loans, borrowers have the choice between several repayment terms, ranging between 10-30 years. In some cases, a lender will allow you to choose your repayment term.
The shorter a loan term, the lower an interest rate is likely to be, which can significantly improve a borrower's overall loan amount. However, this respectively increases the value of monthly mortgage payments as the same loan amount is paid off over a shorter period.
Even long-term fixed-rate loans can come with a low and accessible fixed interest rate that can serve the goals of many investors. -
Adjustable Rates
For investors who do not plan to keep their property in the long term, conventional loans also offer adjustable rates. These rates typically start lower than a fixed-rate loan, but they are subject to change based on market indexes that measure the cost of an issuer borrowing on the credit market.
Your adjustable-rate loan may only be variable for a limited time, ranging between 3, 5, or 7 years. During this time, reduced interest payments can save a borrower thousands, and they still have sufficient time to refinance their mortgage to a fixed rate, sell the property, or pay off their mortgage. -
Wide Range of Property Types
Unlike government-backed mortgages, a conventional loan can be used to purchase a second home, a property with multiple units, or an investment property like a short-term vacation rental.
Some non-conforming mortgages will also allow you to purchase properties such as a farm. With the right lender, you can even buy real estate titled as an LLC rather than an individual investor. -
No Upfront Mortgage Insurance Fee
Conventional loans do not require mortgage insurance premiums to be paid upfront, even if the buyer puts down less than 20%. Whereas government-backed loans may ask a borrower to pay between 1-4% of the loan amount, with a conventional loan you can pay this premium monthly, and only when you put down less than a 20% deposit.
In addition, conventional mortgages usually offer lower insurance fees than their government-backed counterparts - especially if you have a good credit score.
However, those paying less than 20% down payment may be required to take out a private mortgage policy insurance until they own 20% equity in the property. This protects the issuer against default and can significantly affect your bottom line - even if not for the whole duration of the mortgage.
That's right, conventional loans do come with their disadvantages too.
Potential Higher Interest Rate
What are the Disadvantages of a Conventional Loan?
It’s critical to consider both sides of the coin when you’re making major financial decisions, like taking out a mortgage. Even small percentages in interest and insurance can make a significant impact on the amount you pay off over the long term. Here are some downsides to conventional loans that may affect you, depending on your financial situation.
Private Mortgage Insurance
One disadvantage of conventional loans is the likelihood of needing to pay for additional PMI if you put less than 20% down on your property’s purchase price. While government-backed loans are secured by federal government agencies, conventional loans are secured by private lenders such as banks and credit unions. These lenders undertake higher risk when issuing a mortgage to a borrower that doesn’t pay 20% upfront.
Rather than a creditor shouldering the full risk, the borrower must take out a mortgage insurance policy to protect the creditor against default. These extra payments can add a hefty chunk to your monthly mortgage payment, though the good news is you will only have to pay until you have 20% equity in your property.
What Other Options
Do I Have?
Conventional loans offer investors flexibility in repayment options, eligibility guidelines, and property aspirations. The older brother of conventional loans is government-backed loans which are designed to help people who lack a glowing financial record achieve their dream of owning a home. If you have been denied a conventional mortgage, the justification letter may come in handy when making an application for a government-backed loan.
In general, terms tend to be stricter. However, they do empower those without the financial backing or experience required for certain conventional loans to purchase a property and offer home financing solutions to a well-established market. The Mortgage Shop, LLC does not offer Government loans yet, though we understand it’s important to be familiar with available options as you made decisions about your financial future. Government loans are purpose-driven and come with certain limitations of their own.
VA Loans
VA loans are backed by the Department of Veteran Affairs. They are only available to current and former military service personnel, and their spouses. VA loans come with tremendous benefits such as zero down payment and no monthly mortgage insurance premiums.
However, they do require a funding fee of between 1.25-3.3% of your loan amount to offset taxpayer costs to the loan being available for veterans. Further, those eligible are required to occupy the homes they buy with a VA loan, so it cannot be used for secondary homes or investment properties.
USDA Loans
The U.S Department of Agriculture guarantees USDA loans. These are available to eligible applicants purchasing in rural areas. The benefits include zero down payment and low interest rates. However, there are income ceilings, and they are only offered to those who do not exceed the maximum income limit. Sometimes, the entire household income may be considered in these limits rather than the sole income of the purchaser.
Borrowers are not required to pay monthly mortgage insurance. Instead, they are required to pay a guarantee fee which usually equates to around 1% of the loan amount.
FHA Loans
FHA loans are guaranteed by the Federal Housing Administration in the U.S. Not only are they accessible to first-time or low-income buyers, but there are no particular eligibility requirements to getting an FHA loan so long as the property and the borrower qualify for financing.
Credit score requirements are more relaxed than a conventional loan. An Individual with a credit score as low as 500 and a 10% down payment can qualify for an FHA loan. Borrowers who can produce a credit score of 580 are offered minimum down payment options of 3%, which reduces slightly if your credit score is above 620.
FHA loans are a powerful buying tool for many who are aspiring to become a homeowner, though they do have high mortgage fees for the full term of the loan if you pay less than 10% down – which can be up to 30 years.
Final Thoughts
Homebuyers have a lot of modern mortgage options to choose from today. The bottom line is to ensure that you know about the selection so you can choose something that will work for you over the long run.
When compared with government loans, a conventional mortgage can offer homeowners incredible benefits such as flexible terms, adjustable rates, and multiple property types, including second homes or investment properties. In particular, those with non-traditional employment or creative real estate investment plans are more empowered to purchase property than ever before, thanks to the variety of innovative non-conforming mortgage options available on the modern market.
If you have lingering questions about exactly how you can make a conventional mortgage work for you, The Mortgage Shop, LLC is here to guide you through the process. Our experienced team offers investors brilliant, out-of-the-box mortgage solutions to suit their financial goals. If you want to learn how we can do this for you too, contact The Mortgage Shop, LLC today.