Conventional loans boast great rates, lower costs, and home buying flexibility. They are the loan option of choice for about 60% of all mortgage applicants. Conventional loans are also known as conforming loans, since they conform to a set of standards set by Fannie Mae and Freddie Mac. The following are highlights of this program.
- You can use a conventional loan to buy a primary residence, second home, or rental property
- Conventional loans are available in fixed rates, adjustable rates (ARMs), and offer many loan terms usually from 10 to 30 years
- Down payments as low as 3%
- No monthly mortgage insurance with a down payment of at least 20%
- Lower mortgage insurance costs than FHA
- Mortgage insurance is cancelable when home equity reaches 20%
Conventional Loan Requirements
A conventional loan requires as little as 3% down. Fannie Mae and Freddie Mac rolled out a new program in December 2014 allowing for smaller down payments. To read more on the 97% conventional loan, click here.
Conventional financing is now a strong competitor to FHA. While most FHA mortgage insurance remains on the loan for life, conventional mortgage insurance is cancelable. Those who qualify for a conventional loan typically opt for this program over FHA due to lower fees.
Private Mortgage Insurance (PMI)
PMI is required any time you put less than 20% down on a conventional loan. For those with good credit, private mortgage insurance on conventional loans can cost less than FHA mortgage insurance. This is because PMI is risk-based insurance, meaning that the better your credit history, the lower your premiums. PMI is much like auto insurance. You benefit if you have a clean history.
Some of the major private mortgage insurance providers are MGIC, Genworth Financial, RMIC, and Radian. Each company has varying rates for different down payment and credit score scenarios, so make sure your lender shops around for the best PMI cost.
For an in-depth comparison of PMI and FHA mortgage insurance, see our post that compares FHA to the Conventional 97 loan.
2018 Conventional Loan Limits
Generally the conventional loan limit for 2018 is $484,350. However, Fannie Mae and Freddie Mac have designated high-cost areas where limits are higher. For example, a single-family home in Seattle, Washington could have a maximum loan of $592,250. The same home located -in in Los Angeles, California would be eligible for a loan amount up to $636,150.
Increased loan amounts are also available for 2-, 3-, and 4-unit homes. Standard loan limits are as follows.
- The conventional loan limit for a 1-unit home: $484,350
- The conventional loan limit for a 2-unit home: $620,200
- The conventional loan limit for a 3-unit home: $749,650
- The conventional loan limit for a 4-unit home: $931,600
For multi-unit homes located in high-cost areas, loan limits are even higher. For example, a 4-unit home in Honolulu, Hawaii can be financed up to $1.2 million.
Conventional Credit Scores and Loan Level Price Adjustment (LLPA) Index
Generally speaking, conventional loans are best suited for those with a credit score of 680 and above. Applicants with lower scores can still qualify, but their costs may be lower with other programs. Fannie Mae and Freddie Mac impose Loan Level Price Adjustments (LLPA) which cost more the lower your credit score.
For instance, someone with a 740 score putting 20% down on a home has 0.25% added to their loan fee. However, someone with a 660 score putting the same amount down would have a 2.5% fee added. A complete matrix of LLPAs can be found here.
Conventional Loan Debt-to-Income Ratios
Generally, the maximum debt-to-income ratio (DTI) for a conventional loan is 43%. However, exceptions can be made for DTIs as high as 50% with strong compensating factors like high credit and/or lots of cash reserves.
If you have dings on your credit or don’t have a lot of cash reserves, your maximum DTI may be much lower than 43%.
The best way to check the maximum home price for your income level is to get a pre-approval from a conventional loan lender.
Income and Asset Documentation
You will provide documentation proving your income and assets, just like with most other loan types. Here’s a list of some of the things you will need:
- 60 days of bank statements, all pages
- 30 days of pay stubs
- 2 years tax returns if self-employed or have rental properties or non-salary income (retirement, pension, etc.)
- 2 years W2s
- Social security, retirement, and/or pension award letters and 2 years’ 1099s.
- Rental agreements for any investment properties currently owned
Properties Eligible for Conventional Financing
Many types of properties are eligible for conventional financing. These are:
- Single family homes (Detached homes)
- PUDs, or Planned Unit Developments which typically consist of detached homes within a homeowner’s association.
- 2-, 3-, and 4-unit properties
- Some co-op properties
- Manufactured homes (although few lenders offer this program)
Conventional Loans for Condominiums
Many condo projects across the country are eligible for conventional financing. Here are some of the guidelines a condo must meet to be eligible:
- All common areas must be complete and owned by the unit owners or HOA
- At least 51% of the total units in the project must be owner occupied or second homes
- The budget must be adequate
- At least 90% of the units must be sold and currently owned by unit owners (existing projects)
- No single entity may own more than 10% of the units in the project
- The project must be adequately covered by insurance
There may be some exceptions for newly built or converted condo projects. If you are unsure if a unit in a condo project you are interested in meets these guidelines, ask your real estate agent or loan officer.
Second Homes and Investment/Rental Properties
Unlike government loan programs, conventional loans can be used to purchase a second home or a rental. Interest rates and down payment requirements are higher when financing a rental home, but the conventional loan remains one of the few programs available to purchase this this kind of property.
As purchase prices have dropped since the highs of 2007 and 2008, many people are buying rental properties. It may be a great time to look into buying a rental to have sustainable equity and income in the future.
Conventional Loans and Recent Bankruptcy
It’s possible to be approved for a conventional loan after a bankruptcy. There are waiting periods however, and you must demonstrate that you’ve re-established your credit. According to Fannie Mae’s guidelines,
The lender must determine the cause and significance of the derogatory information, verify that sufficient time has elapsed since the date of the last derogatory information, and confirm that the borrower has re-established an acceptable credit history. The lender must make the final decision about the acceptability of a borrower’s credit history when significant derogatory credit information exists.
Here are the waiting periods required after bankruptcy:
Chapter 7 or Chapter 11 Bankruptcy: A four-year waiting period, measured from the discharge or dismissal date is required. A waiting period two years is possible, if extenuating circumstances can be documented, such as job loss that is not expected to recur.
Chapter 13 Bankruptcy: Two years from the discharge date or four years from the dismissal date.
A bankruptcy is never a good thing on your credit report, but it doesn’t necessarily disqualify you from ever getting another mortgage. It’s worth checking your eligibility.
Conventional Loans and Second Mortgages
An option that is rising in popularity is the piggyback mortgage, also called the 80-10-10 or 80-5-15 mortgage.
This loan structure employs a conventional loan as the first mortgage, and a simultaneous second mortgage. This loan structure is allowed using a conforming loan as the first mortgage. For an in-depth look at these loans, see our piggyback loan blog post.
Conventional Loans and Down Payment Gifts
You can use a gift from a relative or eligible non-profit agency to pay for your entire down payment and loan closing costs. Home buyers can now get a conventional loan with zero out-of-pocket costs thanks to this new guideline. See our down payment gift blog post to learn more.
I’m Ready to Apply for a Conventional Loan
Conventional loans are a great option for today’s home buyer. They offer great rates and low fees. Down payments are as low as 3%, and the mortgage insurance is cancelable when home equity reaches 20%.