What Is A Conventional Loan?
Gustan Cho Associates
A conventional loan is a residential mortgage loan that conforms to Fannie Mae and Freddie Mac mortgage lending standards and guidelines. Fannie Mae stands for the Federal National Mortgage Association and Freddie Mac stands for the Federal Home Loan Mortgage Corporation. Both Fannie Mae and Freddie Mac are Government Sponsored Enterprises. Government Sponsored Enterprises is also known as GSE, are entities such as Fannie Mae and Freddie Mac that are sponsored and backed by the federal government but are not part of the federal government. Both the Federal National Mortgage Association ( FANNIE MAE ) and the Federal Home Loan Mortgage Corporation ( FREDDIE MAC ) do not directly offer residential mortgage loans to public customers and are not mortgage lenders. Fannie Mae and Freddie’s function to to purchase mortgage loans that has been originated by banks, credit unions, mortgage bankers, and financial institutional mortgage lenders. Banks, credit unions, mortgage bankers, and institutional mortgage lenders initially use their own warehouse line of credit to fund residential mortgage loans to public customers. Once they use up their warehouse line of credit, they package this loans up and re-sell them on the secondary market to both the Federal National Mortgage Association ( FANNIE MAE ) and to the Federal Home Loan Mortgage Corporation ( FREDDIE MAC ). After the banks, credit unions, mortgage bankers, or institutional lenders sell the mortgage loans in their portfolio to Fannie Mae and to Freddie Mac, they can still service the mortgage loans they have sold.
Fannie Mae And Freddie Mac Lending Guidelines
In order to qualify for a conventional loan, the mortgage loan applicant needs to meet the mortgage lending guidelines and standards of Fannie Mae or Freddie Mac. Fannie Mae has their own mortgage lending guidelines and Freddie Mac has their own set of mortgage lending guidelines. Conventional mortgage lenders all adhere to Fannie Mae and/or Freddie Mac mortgage lending guidelines because they do not intent in keeping the mortgage loans they fund. They package up all of the mortgage loans they fund and bundle them up and re-sell them to the secondary market to Fannie Mae or Freddie Mac. All mortgage loans they originate and fund must conform to the mortgage lending standards and guidelines of the two giant Government Sponsored Enterprises ( GSE ). If the mortgage loan file does not meet the standards and mortgage lending guidelines of Fannie Mae or Freddie Mac, it means that it does not conform and they will not be able to re-sell the mortgage loan and must keep it in their books. Mortgage lenders do not want to keep the loans they fund because it ties up their warehouse line of credit.
What Credit Scores And Debt To Income Ratios Are Required To Qualify For A Conventional Loan?
Fannie Mae and Freddie Mac have minimum credit score and debt to income ratio requirements to qualify for a conventional loan.
Debt to income ratios are the amount of all minimum monthly payment of the mortgage loan applicant divided by the gross monthly income. For a example, if the sum of the mortgage applicant’s total monthly minimum payments is $1,000 and the mortgage loan applicant’s monthly gross income is $3,000, the debt to income ratio for this particular mortgage loan applicant is 33% which is the result of $1,000 divided by $3,000. Maximum debt to income ratio allowed for both Fannie Mae and Freddie Mac conventional loan lending guidelines is capped at 45%. Debt to income ratios is often referred as DTI.
Fannie Mae and Freddie Mac also have set minimum credit score requirements to qualify for a conventional loan. Minimum credit scores required to qualify for a conventional loan is 620 FICO. However, a 620 FICO credit score is considered a very low score for conventional loan mortgage lenders and just because you qualify with a 620 FICO credit score does not mean every mortgage lender will take your mortgage application. Many conventional mortgage lender have something called mortgage lender overlays. Mortgage lender overlays are the mortgage lender’s own set of guidelines and lending standards that are above and beyond the minimum Fannie Mae and/or Freddie Mac’s mortgage lending guidelines. Mortgage lenders are allowed to set their own lending guidelines that have higher standards than Fannie Mae and/or Freddie Mac. There are many instances where a mortgage lender may require a minimum credit score of 680 FICO or higher even though the minimum credit score required by Fannie Mae and Freddie Mac is 620 FICO. Conventional loans are credit sensitive. The lower your credit scores are, the higher your mortgage rate will be. Those with credit scores of 740 FICO or higher will be eligible for the best mortgage rates.
Types Of Conventional Loans And Down Payment Guidelines
Conventional loans are available for owner occupant primary residence properties, second homes, and investment homes.
For owner occupant primary residence homes ( single family only ), the minimum down payment required is 5%. This includes single family homes, townhomes, and warrantable condominiums. Warrantable condominiums are condominium units that 51% or more of the condo unit owners are owner occupants. Non-warrantable condominium units are condo units where 51% or more condominium units are rentals and investor owned.
To qualify for a conventional loan for a second home, you need a minimum of 10% down payment. The second home purchase needs to be at least 60 or more miles from the primary home owner occupant residence or it needs to be located in a resort area like beach front or water front property. A second home buyer cannot qualify for a second home that is down the street from the primary home that is similar in price or square footage. On cases like this, it will be classified as an investment home.
To qualify for a conventional loan for an investment home, the conventional loan borrower needs to put at least a 15% down payment. If the investment home buyer needs to use 75% of the potential income of the investment home to qualify the income towards their debt to income calculations, a 25% down payment is required.
Mortgage Insurance
Any down payment of less than 20% down payment, mortgage insurance is required on all conventional loans. Mortgage insurance can be canceled once the loan to value falls to 78% LTV or if your loan to value falls to 80% loan to value, you can request to the mortgage lender and private mortgage insurance company to have the private mortgage insurance canceled.
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