Conforming

The majority of individuals who apply for a home loan that is not backed by a government program will be applying for a conventional loan. These loans are made directly from the lender who is responsible for determining eligibility requirements and approving or denying applications.

While conventional loans are not backed by any government agency, they must adhere to the guidelines set forth by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Both entities were created by the federal government to administer, buy, and sell conventional mortgage loans and now operate as quasi-government agencies.

 Most lenders will sell the mortgage loans they finance to Freddie Mac or Fannie Mae, and as such they have to follow the underwriting requirements of the respective entity. These guidelines determine the eligibility requirements, loan parameters and set the maximum loan amounts for borrowers in all regions throughout the US. Conventional loans are also called “conforming loans” because they conform to the requirements set forth by Fannie Mae and Freddie Mac.

A conventional loan can be used to purchase a primary residence, second home or investment property and each loan type has specific guidelines which govern down payment, borrower credit profile, income requirements and specific property type.  Conventional loans are available through banks, mortgage lenders, brokerages and credit unions.

Conventional loan guidelines are designed for borrowers with good to excellent credit history, excellent employment record and a significant down payment.  Conventional mortgages traditionally require a 20 percent down payment at closing, but borrowers who don’t have 20% to apply to their purchase can utilize private mortgage insurance (PMI) which allows a down payment as low as 3%.  Conventional loans are typically amortized over 10, 15, 20, 25 or 30 years, but other terms are available depending on the lender.  

Because Fannie Mae and Freddie Mac set the loan limits for conventional loans, borrowers in most parts of the country are limited to a loan amount of $453,100 for a single-family property unless they live in a high cost region which allows loans to exceed the national limit based upon the local cost of housing in which case the limit is $679,650.  In Alaska and Hawaii, the maximum loan amount is $679,650 and the high cost areas are $1,019,475.  Borrowers that utilize a conventional loan to purchase multi-family properties will be able to attain a significantly higher loan amount for 2, 3 or 4 units depending upon the region which the property is located.  

Like most home mortgages, a conventional loan will have closing costs. These costs vary depending upon one’s credit profile, loan product, interest rate and the terms of the loan chosen.  They can include lender fees, discount points, appraisal, closing agent fees, county recording, credit report fees title services. 

The biggest cost on a conventional loan is, of course, the mortgage interest. The interest rate is chosen based on the rate established by the market combined with the amount of risk the borrower represents. In the first years of the mortgage repayment, the majority of the payment goes towards interest, with a smaller portion going towards the principal balance. As time goes on, this gradually reverses as more principal and less interest is paid each month that passes.  This shifts as the borrower continues to pay down the loan.

Conventional loan terms are offered in fixed or adjustable rate periods.  Fixed rate loans have a fixed interest rate for the entire period of the which means that the monthly principal and interest payment will never increase. That monthly payment assurance provides stability and the guarantee that one’s housing expense will never change except for taxes, insurance, and maintenance fees.  

Adjustable rate mortgages, or ARMs, have an interest rate that can change. Typically, these loans have a lower interest rate at the time of origination than a similar fixed-rate loan, but the potential for the loan’s interest rate to increase over time adds a degree of risk.  Most adjustable-rate mortgages will guarantee the interest rate for a set period of time and for borrowers who know a move is imminent in a given period of time, this can provide a more affordable mortgage during that time.    

Borrowers who have an existing loan can refinance to a new conventional mortgage. Refinancing makes sense when interest rates have dropped, if the borrower wishes to change the term of the loan or if the borrower needs to utilize some of the equity which has developed in the property.  Refinancing does not require quite the same process as a purchase as the title is typically not changing hands, but the overall process is similar and most of the closing costs are the same as the original purchase loan, except for the closing agent and title fees.  

QUESTIONS

I need to buy a home that costs more than $453,100. Can I use a conventional loan?

You can purchase a home worth more than the limit if you put more money down on the home, but you won’t be able to use a conventional loan to borrow more than the loan limit. However, you may live in a high-cost area, so check with your lender before you assume that you have to choose a different loan option.

I want to purchase an investment property or vacation home. Can I use a conventional loan?

Conventional loans can be used to purchase investment and vacation properties. There is no requirement that the buyer lives in the property, as long as the buyer is financially able to pay the loan each month. 

If I am paying PMI, do I also need homeowner’s insurance?

PMI is insurance for the lender that protects against the risk of default on a borrower that cannot put down 20 percent. It does not insure the physical property at all. Borrowers will be required to purchase a separate homeowner’s insurance policy to cover their property when purchasing a home with a conventional loan.

I am paying PMI. When can it be removed?

PMI should be removed when the home’s loan-to-value ratio is 80 percent or lower. The loan-to-value ratio is based on the original purchase price. If a borrower feels that property values have increased enough to warrant a new look, then the borrower must pay for a new appraisal. If the appraisal finds that the loan-to-value ratio is now 80 percent and the loan is in good standing, then the PMI will be dropped.