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What Is A Conventional Loan?

A Conventional Loan is a home loan that conforms to the underwriting guidelines provided by Fannie Mae (The Federal National Mortgage Association – FNMA) and Freddie Mac (The Federal Home Loan Mortgage Corporation – FHLMC). This is why a Conventional Loan is also referred to as a Conforming Loan.

Both Fannie Mae and Freddie Mac are Government Sponsored Enterprises (GSE’s) which are a group of financial service corporations created by the United States Congress. They are designed to assist the financial sectors of our economy that provide funding, be more efficient and transparent. The overall goal is to improve the availability and cost of credit to lenders that provide funds to the borrowing public.

Fannie Mae was created in 1938 to purchase residential mortgage loans from banks and local lending institutions. In 1970, Freddie Mac was created to work with Fannie Mae developing uniform mortgage documents with national standards for underwriting loans. (This is where the term, conforming loan, was started.) Any loan today which does not meet these guidelines, in loan size and/or underwriting criteria, is considered a non-conforming or sub-prime loan.

If a loan is greater than what the guidelines allow, it is known as a jumbo loan and therefore subject to higher pricing (or a higher mortgage interest rate). In general, since Fannie Mae and Freddie Mac are continuously buying conforming loans, the pricing and availability of funds for these types of loans are good. This demand also keeps the interest rates they offer lower than if you were considering a non-conforming or sub-prime loan.

    The basic guidelines for a Conventional Loan include:
  • Loans that may be used to purchase or refinance a primary residence or investment property.
  • The home can be a residence for 1-4 families.
  • A 20% down payment is typically required. (Some lenders may offer other options.)
  • There are no restrictions on where a property can be located (unlike a Rural Development loan).
  • The home may be an existing home or new construction, “stick” built or modular.
  • Sellers may contribute toward a buyer’s closing costs and pre-paids based on a percentage of the sales price and down payment. This would be negotiated and agreed upon in the Purchase Agreement.
  • Gift funds are allowed. (Consult a Home Loan Specialist for specific criteria.)
  • Conventional Loans are available with a variety of options including fixed interest, adjustable interest, interest only, balloon payments, negative amortization, construction or remodeling.
    In some cases, where a borrower is contributing less than the required down payment for a Conventional Loan, Private Mortgage Insurance (PMI) may be added. This is an insurance policy to offset losses when a borrower is not able to repay the loan and the lender cannot recover the debt owed after a foreclosure. The annual cost of the PMI can vary based on:
  • terms and type of loan
  • ratio of loan amount to the value of the home (LTV percent)
  • percentage of coverage required by the lender
  • your credit score
  • frequency that the premiums are paid (monthly, annual, or all at once)

If you find a lender who is not requiring PMI with less than a 20% down payment, chances are that they have paid for this insurance through a higher interest rate option. Once PMI insurance is in place, it will remain effective until the Loan to Value (LTV) is at or below 78% of the appraisal, or for 5 years, whichever comes last. Stay in touch with your lender when nearing these criteria to save yourself this expense and to encourage this change.

    In recent years, dramatic shifts in the housing market have had direct impacts on Conventional Loans. In reviewing loans that were foreclosed on, Fannie Mae and Freddie Mac found many common characteristics which have forced changes in certain loan programs or caused them to be removed altogether. For example:
  • An end to 80/20 loans, 80/10/10 loans, or any loan that involved a second mortgage where a buyer was investing at least a 20% down payment.
  • The elimination of certain down payment assistance programs.
  • Requirements of a higher minimum credit score and tighter underwriting guidelines.
  • The elimination of programs where a lender finances over 100% of the sales price.
  • Programs that offered refinancing up to 125% LTV are no longer available.
  • An end to programs offering $0 down payment with reduced PMI.
  • Homes located in a predetermined area with decreasing property values, now also require a larger down payment.

Due to ever changing market conditions, please contact one of our Home Loan Specialists to review the specifics of this home loan product and whether this program will fit your needs.