Conventional Loan Requirements and its benefits
When you think of a mortgage, you probably think of conventional loans or ‘standard loans’ as some people call them.
Not backed by a government agency these loans are backed by private lenders and often require borrower-paid mortgage insurance.
Check to see if you qualify first
If you’re shopping for a home loan, check to see if you qualify first then compare your loan options.
How Conventional Loans Work
Conventional loans have strict guidelines or what may seem ‘strict’ compared to government-backed loans. Here’s why.
Private lenders take the risk of writing conventional loans. There isn’t a government guarantee. In other words, if a borrower defaults, the lender takes the loss. That’s why they require Private Mortgage Insurance in many cases – this borrower-paid insurance protects lenders in the face of default.
You can secure conventional loans from almost any lender. These loans often have the lowest interest rates and fees, but it may be a little harder to meet the requirements.
Conventional Loan Requirements
Here’s the information everyone wants – how do you qualify for a conventional loan? How do you get that loan with the great rates and fees?
While stricter, the conventional loan requirements are not impossible to meet:
- Minimum 620 credit score
- Maximum 28% housing ratio
- Maximum 50% total debt ratio
- Minimum 3% – 5% down payment
- No recent bankruptcies or foreclosures
Conventional Loan Credit Score Requirements
In general, conventional loans require good credit scores – scores of at least 620 are allowed but more realistically 680+ is preferred with much higher rate of approval. This shows lenders that you are a good risk.
A good credit score shows lenders:
- You pay your bills on time
- You don’t overextend your available credit
- You don’t have negative public records (bankruptcy, foreclosure)
Conventional loan credit score requirements may vary by lender. If your credit score is around 620, don’t assume you will automatically qualify just because you meet the minimum qualifications, especially if you don’t have compensating factors which we discuss later in this article.
Conventional Loan Maximum Debt Ratios
Conventional lenders look at two debt ratios – your front-end (housing) ratio and your back-end (total) debt ratio.
- Housing ratio – Your housing ratio is the comparison of your total mortgage payment to your gross monthly income. Your total housing payment includes the principal, interest, real estate taxes, mortgage insurance, and PMI (if applicable). This ratio should be 28% or less of your gross monthly income (income before taxes).
- Total debt ratio – Your total debts include your credit card payments, personal loan payments, car payments, and student loan payments, along with any other installment loans. It doesn’t include everyday expenses, such as utilities, insurance, or groceries, though. This ratio should be 36% or less of your gross monthly income (income before taxes).
Don’t worry if your DTI exceeds the limits here. If you have ‘other factors’ that make up for the higher debt ratios up to 50% and lenders think you can afford the loan, you may still be a good candidate.
How Debt To Income Ratio (DTI) works:
|Monthly Gross Income||$5,000|
|Proposed mortgage monthly payment||$1,000|
|Housing Ratio Calculation: ($1,000 / $5,000 ) x 100||20% Housing DTI Ratio|
|Monthly Gross Income||$5,000|
|Proposed mortgage monthly payment||$1,000|
|Total monthly expenses reporting on credit (car payment, credit card payments, etc..)||$800|
|Total Ratio Calculation:|
(($1,000 + 800) / $5,000 ) x 100
|36% Total DTI Ratio|
For simplicity of calculation, above calculations are for W2 salaried income earners.
For hourly wage, self-employed, business owners, or 1099 commission earners must calculate their qualifying income first before applying to above calculations.
If you’d like to find out what your qualifying income is please get in touch with us.
Conventional Loan Down Payment Requirements
Here’s some good news. Most people assume a 20% conventional loan down payment is necessary, but it’s not. In fact, you can get one with as little as 3% or 5% down.
Do lenders want a 20% down payment? Of course – it lowers your risk of default by giving you more ‘skin in the game.’ The more money you invest in the home, the less likely you are to default on your payments.
If you do put down less than 20%, you must pay Private Mortgage Insurance. This protects the lender should you default on your loan.
Conventional loans offer a few options when making the down payment:
- Put at least 3% or 5% down and pay PMI unless you make a 20% down payment
- Get a piggyback loan, borrowing 80% with a conventional loan, 20% from a home equity loan (2nd loan), and make a 10% down payment (you don’t pay PMI)
- Get gift funds from a qualified family member
Conventional Loan Employment Requirements
Conventional loan requirements state you need a 2-year history at your job. That doesn’t mean if you changed jobs within the last year or so that you won’t qualify though.
Lenders need to see consistency, which may look like any of the following:
- You changed jobs but stayed within the same industry – Lenders look at this as having the same job as you have the history to prove longevity
- You changed jobs and industries – As long as you have proof of training or education that proves you can be successful in the new industry you may qualify. Some lenders may require a certain amount of time at the new job, such as 6 months.
- You got a new position but stayed within the same company – If you changed roles, but stayed within the same company, you may qualify. Like changing industries, you may have to prove the qualifications you have to succeed at the job
NOTE: Unlike FHA loans, you do not need to stay with the new employer for 6 months to qualify even though you changed employer.
Conventional Loan Documentation Requirements
Lenders need proof of each qualification. Each lender may have its own requirements, but in general, expect to provide:
- Your pay stubs covering the last 30 days of employment
- W-2s/1099s from the last 2 years
- Tax returns from the last 2 years if you’re self-employed or work on commission
- Bank statements for the last 2 months to show your down payment funds and any reserves
- An offer letter from a future employer if you haven’t started yet
- Proof of your identity
- Purchase contract signed by all parties (purchase transaction only)
- Current most recent mortgage statement (refinance only)
- Current most recent proof of homeowner’s insurance (refinance only)
- Current most recent HOA statement/payment coupon (refinance only)
If you file personal tax returns and business tax returns separately, we’d need both returns for last 2 years.
Conventional Loan Property and Appraisal Requirements
Conventional loan requirements when it comes to appraisals are among the most lenient when compared to government loans, such as FHA loans. As long as the appraiser determines the home is safe and structurally sound, it should pass the appraisal inspection.
The value, however, is what determines your ability to get a conventional loan. As we discussed, conventional loans allow down payments as low as 3%- 5%. But if the home doesn’t appraise high enough, you may have to make up the difference.
Here’s an example.
You bid $150,000 for a home and the seller accepts it. You sign the contract and start processing the loan. You plan to put down 10%, so $15,000. The appraiser determines the home is worth $145,000. The lender uses the $145,000 to determine your loan amount rather than the $150,000 sales price. You can either make up the difference by coming up with the extra $5,000 or re-negotiate the sales price to $145,000.
Conventional Loan Limits
Each year, the Federal Housing Finance Agency reassesses the maximum conventional loan limits based on the average housing prices.
In 2020, the maximum conventional loan limit is $510,400 in all areas, except high-cost areas where the limit is $765,600. Certain areas of California, Utah, and Washington fall into the high-cost areas with higher loan limits.
Conforming loan limits are updated at the end of every calendar year. Make sure you are up-to-date on current loan limits!
More: Conforming loan limits
As we’ve discussed, if you don’t put 20% down on a home, you pay PMI. Your PMI rates vary based on your credit score and loan-to-value ratio. The better your credit and the lower your LTV, the less PMI you’ll pay.
The good news is that you can cancel PMI once you owe less than 80% of the home’s value. You’ll know when the PMI drops off your payment automatically by looking at your amortization table. But, you can also request cancelation sooner if you pay your loan down faster or your home appreciates. You may have to pay for another appraisal, but if you can cancel PMI, it may be worth it.
The actual LTV you need to cancel your PMI without refinancing may vary from 75% to 80% of home value depending on the lender.
Lenders look at the big picture when determining your eligibility for a conventional loan. The conventional loan requirements are there as a guide, but lenders can use their own judgment.
For example, if your credit score is right around the minimum requirement of 620, but you have a low debt-to-income ratio, higher down payment, and stable employment, the other three factors may make up for your lower credit score, allowing the lender to approve the loan.
The key is to create a well-rounded application. Show lenders you are a good risk not just with a good credit score, but in all areas of your financial life.
The Types of Conventional Loans
You mostly hear about fixed-rate conventional loans, but you can choose an adjustable rate loan too. Here’s the difference:
- Fixed rate loan – Your interest rate never changes. Once you lock in a rate, it stays there for the rest of the term. Unless you refinance or pay off the loan, you’ll always know your principal and interest payment for the life of the loan.
- Adjustable rate loan – Your interest rate remains fixed for a specified period (the introductory period). After the introductory period, the rate may change annually based on the chosen index and margin. The most common ARMs are the 3/1, 5/1, and 7/1 ARMs, with the first number indicating the introductory period.
Conventional loans offer the lowest interest rates and fees, as well as PMI that doesn’t last forever. The conventional loan requirements aren’t as strict as many people assume. It’s a great loan program to try to obtain when buying a home or even financing your existing mortgage.