Simplifying New Home Financing:
Your Comprehensive Guide to Conventional Home Loans
Navigating the path toward homeownership can sometimes feel like a venture into a labyrinth, especially when understanding the different mortgage options available for new home buyers.
Conventional loans are a solid choice, often favored by many second-time homebuyers or investors for their ease and flexibility.
They can provide an excellent avenue to finance your journey to owning a brand-new home, whether you're a first-time buyer or a seasoned homeowner looking for a move-up home.
A conventional home loan can offer significant benefits, ranging from various loan terms to lower costs. However, it's not one-size-fits-all, and understanding whether it's the right fit for you requires a deeper understanding of the requirements for a conventional home loan.
This comprehensive guide aims to help you unravel the intricacies of conventional loans, helping you decide on financing for your new construction home.
With clear insights into their structure, benefits, requirements and application process, you'll be well-equipped to decide if a conventional loan is a path to unlocking the door to your new home.
What is a Conventional Home Loan?
In its simplest definition, a conventional mortgage loan is a home loan not guaranteed or insured by the federal government.
Unlike government-insured loans such as Federal Housing Administration (FHA) loans, U.S. Department of Agriculture (USDA) loans or Veterans Affairs (VA) loans, conventional loans are backed and serviced by private lenders like banks, credit unions and mortgage companies.
These types of loans follow the standards set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
Government-sponsored enterprises (GSEs) buy and guarantee mortgages from lenders that follow their guidelines, which helps add liquidity to the mortgage market, giving lenders the capital and freedom to continue lending to homebuyers.
Conventional loans can come in various forms, including fixed-rate and adjustable-rate mortgages. They can also be conforming or non-conforming, depending on whether they meet the limits set by Fannie Mae and Freddie Mac.
While there are many considerations when choosing the type of home loan that fits your needs, conventional loans are popular for several reasons. Continue reading to learn why you may opt for one of these loans to finance your new home.
Why Choose a Conventional Loan to Finance Your New Home Purchase?
Choosing a conventional loan for your new home purchase can offer you many advantages when deciding the best financing option. Let's dive into some main reasons home buyers opt for conventional loans.
Greater Variety of Property Types
One of the significant advantages of conventional loans is the flexibility in the type of properties you can purchase.
Conventional loans are particularly beneficial for those interested in buying a second home, rental property or a new home yet to be constructed, such as a custom home. In contrast, government-insured loans like USDA, FHA and VA home loans have stricter requirements and limitations.
More Flexibility
Conventional loans offer a great deal of freedom. Whether you're looking for a fixed-rate or adjustable-rate mortgage, a mortgage broker can structure your loan to meet your needs. The loan terms are flexible, with options ranging from 10 to 30 years. Buyers can use them to purchase a primary residence, second home or investment property; they have fewer restrictions than FHA home loans.
Additionally, conventional loans come in conforming and non-conforming (jumbo) loan sizes, providing financing solutions for a wide range of property values.
Increased PMI Control
Private Mortgage Insurance (PMI) is typically required for conventional loans when the down payment is less than 20% of the home's value. The benefit, however, is that once you've built up 20% equity in your home, you can request to have the PMI removed, thereby reducing your monthly mortgage payment.
Removing private mortgage insurance is only sometimes an option with FHA loans. Mortgage insurance is required for the life of the loan unless you refinance or make a down payment of 10%.
No Income Limitations
While some loan types, like USDA loans or specific down payment assistance programs, have income limitations, conventional loans do not. This lack of income cap makes conventional loans a feasible option for high-income earners purchasing homes in higher price ranges.
Are There Any Drawbacks to Conventional Loans?
Despite the numerous advantages of conventional loans, there are some factors that prospective homeowners should consider.
Higher Credit Score Requirements
Conventional loans often have stricter credit score requirements when compared to government-backed loans. Most lenders require a minimum credit score of 620, and if you're after the best interest rates, a score in the mid-700s is necessary.
Larger Down Payments
Unless you have stellar credit, stable income and a low debt-to-income ratio, conventional loans typically require a higher down payment than FHA or VA loans. While getting a traditional mortgage with a down payment of 3% is possible, you may have higher interest rates.
Stricter Loan Approval Standards
Since conventional loans are not government-backed, the risk to the lender is higher, leading to more stringent approval standards. Beyond credit scores and down payments, lenders will look closely at your debt-to-income ratio, employment history and overall financial stability.
Despite these potential challenges, many homebuyers find that the advantages of conventional loans, such as flexible terms and property choices, can far outweigh these drawbacks. Therefore, weighing these factors against your financial situation and homeownership goals is essential.
What Are the Requirements for a Conventional Loan?
Qualifying for a conventional loan involves meeting certain financial criteria. While specific requirements can vary between lenders, these are the guidelines set by Fannie and Freddie.
Minimum Credit Score
As mentioned, most lenders require a minimum credit score of 620 to qualify for conventional home mortgages. However, a credit score in the mid-700s (740) or above is often preferred to secure the most favorable interest rates and down payment options.
Stable Income and Employment
Lenders typically require proof of stable income and employment. They may ask for pay stubs, W-2s or tax returns from the previous two years to verify your earnings. Self-employed individuals must meet the same standards as W-2 employees. Still, lenders may request additional documentation, such as profit and loss statements, to prove your cash flow as a business owner.
Down Payment
For a conventional loan, borrowers can qualify for a down payment as low as 3%. Borrowers with high debt-to-income ratios or low credit scores may need to put more down.
A 20% down payment will eliminate the need for private mortgage insurance (PMI).
Down payment requirements are higher if you ask for a jumbo loan or a second mortgage. For jumbo loans, the minimum down payment required is 5%; second mortgages usually require a down payment of 10%; borrowers with low credit scores or high debt-to-income ratios may need to put down as much as 30%.
Debt-to-Income Ratio (DTI)
Your DTI ratio – the percentage of your monthly income that goes toward paying your debts – plays a significant role in the loan approval process. Most lenders prefer a DTI ratio of 36% or lower, but you can secure financing with a DTI ratio of 49%.
Loan Limits
Conforming loans fall in the conventional loan category and have maximum limits set by Fannie Mae and Freddie Mac. In most of the United States, the 2023 traditional loan limit for a single-family home is $726,200, an increase of $79,000 from $647,200 in 2022.
The loan limit for designated high-cost areas is $1,089,300, 50% more than the standard limit.
Property Appraisal
The home you're buying must appraise for the purchase price or higher. If it appraises for less, you'll need to renegotiate the contract, make a larger down payment or potentially walk away from the purchase.
Of course, these are only general guidelines, and individual lender requirements may vary. Please consult with your lender to understand their eligibility needs.
What Types of Conventional Home Loans Are Available?
Conventional home loans come in two main categories: conforming and non-conforming loans. Understanding these categories can help you choose the best type of loan for your specific needs.
Conforming Loans
Conforming loans "conform" to the guidelines and value limits set by Fannie Mae and Freddie Mac mentioned above.
Conforming loans are popular because they typically offer lower interest rates and more flexible terms than non-conforming loans. Additionally, because Fannie Mae and Freddie Mac back them, lenders feel more secure and are more likely to offer these loans to a wide range of borrowers.
Non-Conforming Loans
Non-conforming loans, on the other hand, do not meet Fannie Mae and Freddie Mac guidelines. The most common type of non-conforming loan is a jumbo loan, which exceeds the maximum loan limits set for conforming loans.
These loans finance higher-end properties and homes in highly competitive local real estate markets. Fannie Mae and Freddie Mac do not secure or guarantee jumbo loans; they typically have more stringent credit requirements, require larger down payments and have higher interest rates.
However, a jumbo loan could be an excellent tool to finance your home purchase if you want to buy a high-value property with a solid financial profile.
Remember, the type of conventional loan that's right for you will depend on your financial situation, the local housing market and the home price you're interested in buying.
How Do You Secure a Conventional Loan?
Securing a conventional loan involves several steps. Here's a simplified walkthrough of the process:
Step 1: Assess Your Financial Situation
Before diving into the loan process, assess your financial situation.
This process involves checking your credit score, calculating your debt-to-income ratio and understanding how much you can afford for a down payment, closing costs and monthly mortgage payments.
Step 2: Choose a Lender
Research various mortgage lenders to find one that offers the best terms for a conventional loan. Lenders could be a bank, credit union or mortgage broker. Compare interest rates, loan terms and customer service reviews before deciding.
Step 3: Get Pre-Approved
Apply for a mortgage pre-approval. A pre-approval letter will show you how much you can borrow and show sellers that you're a serious buyer. Remember, pre-approval is not a loan guarantee but can help guide your home search.
Step 4: Choose a Home
Once pre-approved, you can begin shopping for a home. Work with a real estate agent who understands your needs and budget. Once you find a home you love, make an offer.
Step 5: Finalize Your Loan
After accepting your offer, work with your lender to finalize your loan. Finalizing your loan involves a home appraisal inspection, and underwriting. Once your loan is approved, you'll begin closing on your new home.
Remember, each lender may have a slightly different process, so it's crucial to communicate with your chosen lender and ask any questions you might have.
Embrace the Power of Conventional Loans for New Home Homeownership
Purchasing a home, especially a new one, is an exciting and significant milestone. With a conventional home loan, you can embrace the flexibility, control and broad property options they offer.
However, it's crucial to understand the ins and outs of this financing option to ensure it's best for you.
Whether you're a first-time homebuyer or an experienced homeowner looking for a change, the proper knowledge can transform your home-buying experience. It's not just about meeting the requirements or choosing the loan type; it's about making informed decisions that align with your financial situation and homeownership goals.
LGI Homes proudly collaborates with LGI Mortgage Solutions to ensure you receive comprehensive and personalized support throughout your home-buying journey. Our shared commitment to creating homeowner success stories means we're there every step, from the initial consideration of a conventional loan to the moment you step over the threshold into your new LGI home.
LGI Mortgage Solutions can guide you through the loan application, helping you secure the best terms for your new home purchase.
Contact us today to discuss your home and loan requirements in more detail.