What are Conventional Loans?
Conventional loans are mortgage loans that are not backed or insured by a government agency, such as the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). Instead, they are offered by private lenders like banks, credit unions, and mortgage companies, and conform to the standards set by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac.
Benefits of Conventional Loans for First-Time Home Buyers
As a first-time home buyer, you may find conventional loans to be an attractive option for various reasons:
- Lower Interest Rates: Conventional loans often come with lower interest rates compared to government-backed loans, which can help you save money over the life of your mortgage.
- Flexible Down Payment Options: You can choose from various down payment options, with some conventional loans requiring as little as 3% down.
- No Mortgage Insurance Requirement with 20% Down Payment: If you can make a down payment of 20% or more, you can avoid paying private mortgage insurance (PMI), potentially saving you thousands of dollars over the life of your loan.
- Multiple Property Types: Conventional loans can be used to finance various property types, including single-family homes, multi-unit properties, and condominiums.
- Refinancing Options: Conventional loans offer various refinancing options, including the option to refinance into a lower interest rate or change the loan term.
Understanding Conventional Loan Requirements
Although conventional loan requirements may vary depending on the lender, most lenders will look for the following factors when approving a mortgage:
- Credit Score: A higher credit score typically results in better loan terms and interest rates. Most conventional loans require a minimum credit score of 620, but a score of 740 or higher can help you secure the best interest rates.
- Debt-to-Income Ratio (DTI): Your DTI is the percentage of your monthly gross income that goes toward debt payments. Lenders prefer a DTI below 43%, but some may consider higher ratios with compensating factors.
- Employment History: Lenders generally require a stable employment history of at least two years to ensure that you have a steady income to make your mortgage payments.
- Income and Assets: Lenders will verify your income and assets to ensure you can afford the mortgage payments. Be prepared to provide documentation, such as pay stubs, tax returns, and bank statements.
- Property Appraisal: The property you want to buy must undergo an appraisal to determine its market value. Lenders use this value to ensure the loan amount does not exceed the property’s worth.
Types of Conventional Loans: Fixed-Rate vs. Adjustable-Rate Mortgages
Conventional loans can be broadly categorized into two types: fixed-rate mortgages (FRMs) and adjustable-rate mortgages (ARMs).
- Fixed-Rate Mortgages (FRMs): With an FRM, your interest rate remains the same throughout the loan term, ensuring predictable monthly payments. Common loan terms for FRMs include 15, 20, and 30 years. FRMs are ideal for borrowers who prefer stability and plan to stay in their home for an extended period.
- Adjustable-Rate Mortgages (ARMs): ARMs come with an initial fixed-rate period, typically ranging from 3 to 10 years. After this period, the interest rate adjusts annually based on a specific index, such as the London Interbank Offered Rate (LIBOR) or the Secured Overnight Financing Rate (SOFR). ARMs can be a good option for borrowers who anticipate an increase in income or plan to sell or refinance their home before the fixed-rate period expires.
Conventional Loan Down Payment Options
Down payment requirements for conventional loans can range from as low as 3% to 20% or more. The amount you choose to put down can impact your interest rate, monthly payment, and whether or not you need to pay private mortgage insurance (PMI).
- Low Down Payment Options (3%-5%): Some conventional loan programs, such as Fannie Mae’s HomeReady® and Freddie Mac’s Home Possible®, allow first-time home buyers to put down as little as 3%. Keep in mind that a smaller down payment may result in higher interest rates and the need for PMI.
- Standard Down Payment (20%): A 20% down payment allows you to avoid PMI and secure better loan terms. If you can afford a larger down payment, it can save you money in the long run.
Conventional Loan Limits and Loan-to-Value Ratios
Conventional loans adhere to loan limits set by the Federal Housing Finance Agency (FHFA). In 2023, the conforming loan limit for single-family homes in most areas is $647,200, while high-cost areas have a limit of $970,800.
Loan-to-value (LTV) ratio is the percentage of the home’s value that you’re borrowing. A lower LTV ratio means you have more equity in your home and typically results in better loan terms. Conventional loans usually have a maximum LTV ratio of 97% for primary residences.
Applying for a Conventional Loan: The Step-by-Step Process
Follow these steps to apply for a conventional loan:
- Evaluate Your Financial Situation: Assess your credit score, DTI ratio, and available funds for a down payment to determine if a conventional loan is right for you.
- Compare Lenders: Shop around and compare interest rates, fees, and loan terms offered by different lenders to find the best fit for your financial situation.
- Get Pre-Approved: Apply for a mortgage pre-approval to determine how much you can borrow and demonstrate your financial readiness to potential sellers.
- Find a Home: Work with a real estate agent to find a property that meets your needs and budget.
- Make an Offer: Once you find your ideal home, submit a competitive offer to the seller. Your real estate agent can help you determine the right price and negotiate on your behalf.
- Mortgage Application: After your offer is accepted, complete a formal mortgage application with your chosen lender. Be prepared to provide documentation, such as pay stubs, tax returns, and bank statements, to verify your income and assets.
- Home Inspection and Appraisal: Hire a professional home inspector to identify any potential issues with the property. The lender will also order an appraisal to confirm the home’s value.
- Underwriting: The lender’s underwriter will review your loan application, verify your documentation, and assess the property’s appraisal and inspection reports to determine if the loan should be approved.
- Loan Approval and Closing: If the underwriter approves your loan, you’ll receive a loan commitment letter outlining the terms of your mortgage. At closing, you’ll sign the final loan documents, pay any closing costs, and take possession of your new home.
Conventional loans offer first-time home buyers various benefits, including lower interest rates, flexible down payment options, and the ability to finance different property types. By understanding the requirements, types, and application process for conventional loans, you can make an informed decision when choosing the right mortgage option for your dream home. At LBC Mortgage, we’re here to guide you through every step of the home buying journey. Contact us today to learn more about our conventional loan offerings and how we can help you achieve your homeownership goals.