Benefits and Considerations
Conventional mortgages can be obtained when you meet the underwriting and funding criteria of Fannie Mae® and Freddie Mac®. Conventional mortgages are ideal for home buyers with excellent credit and can pass the general guidelines for Debt to Income Ratio and having the minimum down payment.
Conventional loans can be fixed-rate or adjustable-rate mortgages and the options come in a variety of loan terms. They are available for primary residences, vacation homes and investment properties. The underwriting guidelines vary for each occupancy type, with larger down payments required for vacation and investment homes.
Unlike FHA loans, conventional mortgages base their mortgage insurance requirements almost exclusively on loan-to-value. If you are putting 20 percent or more down you will not have mortgage insurance.
For many would-be homebuyers, conventional mortgage financing presents the best value mortgage loan, especially if you are putting 20 percent or more toward a down payment and have strong credit.
Conventional loans are for primary residences only, if you want to finance a second home or investment property, you will need to use conventional mortgage as FHA, VA and USDA loans.
As mentioned above, conventional loans offer a variety of loan terms. Your loan term combined with the down payment amount plays a major part in the total amount of mortgage interest you will pay over the life of the loan.
Here’s a hypothetical life of the loan example:
- 350,000 loan amount
- Excellent credit (above 740)
- 20% down payment
- Payments do NOT include property taxes or insurance
On a 30 year fixed rate mortgage with a 4% interest rate:
- Monthly payment – $1,671
- Total interest paid – $251,543
On a 20 year fixed rate term at a 3.75% interest rate:
- Monthly payment – $2,075
- Total interest paid – $148,025
On a 15 year fixed rate at 3.25% interest rate:
- Monthly payment – $2,459
- Total interest paid – $92,681
You might of noticed that the same interest rate was not used for all the scenarios. In general, the shorter the loan term the lower the interest rate.
You will almost always see 15 year fixed rates are lower than 30 year fixed rates.
Similarly, rates for investment properties and second homes will also be higher than those of a primary residence.
It’s all about risk with conventional mortgage loans.
You should understand the risk factors that are used with risk-based pricing behind the mortgage rate that you can obtain as we have discussed above, but here’s a more comprehensive list:
- Debt-to-Income Ratio – 43 percent or less is preferred
- Assets/Reserves – after cash-to-close (down payment + closing costs) assets of 6 months of mortgage payments preferred
- Property Type – single-family residence, condo, townhome or manufactured housing
- Occupancy – primary residence, second home or investment property
- Credit Score – a 740 score is preferred, but loans available down to a 620 score
If you don’t meet all the criteria above it does not mean you are ineligible for a conventional mortgage, but you do present a higher risk and will likely pay a little more on your mortgage rate.
That’s how risk-based pricing works.
Regardless, 35-50 percent of all mortgage loans meeting the conventional mortgage guidelines, they are clearly a great option for many borrowers.