The majority of mortgage loans made in the conventional loan market adhere to the underwriting guidelines of Freddie Mac and Fannie Mae for conforming loans. Conventional loans are by definition “conforming” if they are generally $417,000 or a lesser loan amount for a single-family residence. Conforming loan limits are designated by area and can reach up to $625,000 in some states such as Hawaii and Alaska, but for the most part $417,000 is the most wide-spread conforming loan limit. Conventional loan limits greater than $417,000 are considered “nonconforming” loans, or jumbo, and the interest rates are normally substantially higher.
Conventional loans through Freddie Mac and Fannie Mae have established guidelines, or pricing tiers, for borrower credit scores, loan-to-value ratios, minimum down payments, and income requirements. For instance, most conventional mortgage purchase loans require a minimum 3% to 20% down payment range and allow for a 100% gift from blood or by-marriage relatives. Two of the most important factors when purchasing a home with a conventional loan are the term of the loan and loan-to-value ratio (LTV), or down payment amount:
- 97% LTV with a 30-year term
- 95% LTV with a 30-year term
- 90% LTV with a 30-year term
- 85% LTV with a 30-year term
- 80% LTV with a 30-year term
The term of the loan can vary from longer or shorter depending on the borrower’s preference and ability to qualify. A shorter-term mortgage will typically result in a lower interest rate.
- Mortgage Insurance
Any loans with loan-to-value ratios greater than 80% are subject by the lenders to carry a private mortgage insurance policy. Please see our Mortgage Insurance Options page for further details and choices on this topic. Private monthly mortgage insurance can be eliminated on a conventional loan. However, the process and requirements to cancel private mortgage insurance can vary between lenders.
- Credit Score
Presently, conventional guidelines are changing quite frequently. A minimum FICO score requirement for a competitive interest rate is higher than those required for an FHA loan. The borrower currently needs a minimum 640 credit score to qualify for a conventional loan and any credit score below a 740 is subject to the lender adding fees, which can be sizable, as in the several-percent range, as a borrower’s credit score drops compared to loan-to-value ratios.
- Interest Rate Pricing
On the contrary, borrowers with excellent credit scores over 740 and loan-to-value ratios under 80% are eligible for lower interest rate pricing and lender credits. These lender credits are used to lower the interest rates and/or as subsidies towards lowering the overall cost of the loan transaction. As the loan-to value ratio decreases (as low as 60% LTV), or inversely as the equity increases (up to 40%), the more favorable the interest rate pricing becomes.
- Adjustable-Rate Mortgage
Conventional loans incorporate either a fixed or adjustable interest rate program. Under standard market conditions, adjustable-rate mortgages (ARMs) usually result in a lower interest rate for the shorter fixed term of the loan. Once the initial fixed period has expired, the ARM’s interest rate fluctuates in relation to customary financial indexes, such as the COFI or LIBOR. The new variable rate allows the monthly mortgage payments to rise or fall according to the loan’s base rate, plus the index.
Conventional loans are ideal for borrowers with exceptional credit and who can meet the expense of a more sizable down payment.
The Federal Housing Administration (FHA), which is a part of HUD, insures this loan so the lender can offer a more competitive deal. This type of loan is popular among first-time home buyers. However, being a first-time buyer is not a requirement. FHA loans are normally restricted to a primary residence and only one FHA loan per person, unless the borrower or borrowers can prove that their family has outgrown the current residence or if an employment relocation is taking place. Either way, these circumstances are up to the lender and underwriter’s discretion.
FHA’s minimum requirement for down payment for a purchase is 3.5% or $3,500 on a sale price of $100,000. Technically, FHA does not require a minimum credit score; however, lenders have what are called “lender overlays”, which usually require a credit score of at least 640. Other conditions can apply to credit scores down to 500. FHA programs come in a large assortment (e.g., 30-year, 30-Year 2/1 Buydown, 15-Year, 3/1 and 5/1 ARMs).
The advantage of doing an FHA 15-Year loan with 10% down payment or equity is that the consumer may not have to pay monthly mortgage insurance. This may change with new rules in 2013. All Conventional loans require a 20% down payment to eliminate mortgage insurance.
On a 30-Year fixed loan with 3.5% down payment, FHA requires that you pay a monthly mortgage insurance fee. Worth mentioning is that the mortgage insurance fee factor will decrease with a 5% plus down payment. Loan amounts are restricted to county loan limits, which vary from state to state.
Per FHA guidelines and in addition to the monthly mortgage insurance, the borrower or borrowers will pay an upfront mortgage insurance fee. This fee can be financed or paid in cash, but this means that interest on that fee is paid over the term of the loan.
With Conventional loan programs, the borrower or borrowers can appeal to have the mortgage insurance removed once the property’s loan-to-value ratio reaches 80%. With FHA mortgages, depending on when you closed your FHA loan, the mortgage insurance premium may apply for the life of the loan.
Fannie Mae – HomePath
This special program allows a potential buyer to purchase a Fannie Mae-owned property with a down payment as low as 3 percent, funded by the borrower’s own savings, a grant, a gift, or a loan from a nonprofit organization. HomePath mortgages are eligible as primary residences, second homes, and investment properties. Possibly the largest incentive for the HomePath program is the mortgage does not require a property appraisal, mortgage insurance premium, or monthly mortgage insurance. Seller contribution limits are expanded for closing costs allowed. Additionally, HomePath offers renovation mortgages. For more information, and to search for Fannie Mae-owned eligible homes, please visit HomePath.com.
The VA Home Loan program is backed by the U.S. Department of Veteran Affairs. This program allows veterans, with qualifying income and credit, to purchase a primary residence without putting any down payment funds towards the sale price of the home, as long as that sale price does not exceed the appraised value of the property. There is no maximum VA loan amount; however, lenders will generally limit VA loans to the county’s Conforming loan limit of $417,000. For loans up to this limit amount, it is typically possible for qualified veterans to obtain no down payment financing. A veteran’s maximum entitlement is $36,000 (or up to $104, 250 for certain loans over $144,000). Lenders will usually loan up to 4 times a veteran’s available entitlement without a down payment, provided the veteran’s income and credit qualify, and the property appraises for the sale price. Additionally, VA loans require no mortgage insurance premiums and monthly mortgage insurance fees. VA loans require no mortgage insurance premiums and monthly mortgage insurance fees. Be aware that VA also requires a funding fee that can range between one and three percent depending on current guidelines. This can be rolled into your loan amount or paid in cash at time of refinance or purchase.
USDA Rural Housing – Conventional No Mortgage Insurance
The Rural Housing loan is guaranteed by the USDA’s Rural Housing Service. This mortgage program is designed for low to moderate income families in rural areas. The USDA’s “guarantee” means that they will compensate any lender for any USDA Rural Housing loan in default. Additionally, this “guarantee” means that lenders are more than willing to lend their money to individuals with less than stellar credit and no down payment requirement. Most lenders will allow credit scores as low as a 620. The “guarantee” also indicates that lenders will not require mortgage insurance for Rural Housing loans. Nonetheless, Rural Housing loans charge a 3.5% upfront funding fee, which can be financed into the loan. In the scenario of financing the funding fee, the final loan amount will equal 103.5% of the property purchase price. This means the consumer begins home ownership with a mortgage larger than the home is worth. The two major limitations of this program are income restrictions and the property must be located in a designated rural area. Please go to the USDA’s website to check income and property location eligibility.
Mortgage Insurance Options For Conventional Loans
Consider the differences between the different private mortgage insurance (PMI) structures themselves. Monthly PMI, single premium financed, and lender paid all have their place. There are substantial benefits to each of these options depending on your overall financial needs.
- Lender Paid PMI (LPMI)
This product is now the industry leader. In exchange for a slightly higher interest rate, the client avoids paying PMI insurance for the duration of the loan. Even though the higher rate remains for the extent of the loan term, this mortgage insurance option may provide the borrower with the lowest monthly payment (typically LTV’s of 97% or less).
- Monthly PMI (BPMI)
Probably the most common PMI policy issued. Can often be the most expensive. Probably the worst deal for the client and is only really beneficial if the loan is going to be short-term in nature, or the borrower will have an accelerated equity position sooner rather than later. While other plans do exist (such as annual) these are the three that are the most common and the pitfalls/benefits associated with them.
- Single Premium Financed PMI (Temporarily discontinued by Fannie Mae and Freddie Mac)
Perhaps the best kept secret in the industry. Why? Because many lenders don’t understand how it works. Single Premium PMI allows you to finance the MI premium as a lump sum into the loan amount. This eliminates the need for monthly PMI and can give the borrower a substantially lower monthly payment. Yes, this is an acceptable form of mortgage insurance with Fannie and Freddie (works similar to the upfront mortgage insurance premium (UFMIP) for an FHA loan). The loan-to-value ratio (LTV) is calculated prior to adding the cost of the mortgage insurance premium to the loan (resembling UFMIP on FHA).