There may be no more confusing — and jargon-filled — topic in the world than mortgage lending (rivaled, perhaps, only by the corporate tax code).
And there might be no more misunderstood concept than a “conventional mortgage.” What makes it “conventional?” Is it the length of the mortgage? Or the rate? And what can you do to make sure you get the best conventional mortgage you need to reach your financial goals?
So, whether you’re thinking about buying your first home — and are a complete newbie when it comes to mortgage options — or you’ve owned a home in the past and you want to make sure nothing slips through the cracks, here are answers to the most common mortgage lending questions.
(Note: This is Part I in our series on mortgages. Be sure to check out Part 2: Second Mortgage Q&A.)
Your Conventional Mortgage Lending Questions Answered
1. What is a conventional mortgage?
A conventional mortgage is a loan not backed by the government and does not need to follow the rules for lending set forth by Fannie Mae or Freddie Mac. Conversely, conventional loans are backed by banks, private lenders or credit unions.
Conventional loans come with two mortgage options: either a fixed interest rate or an adjustable interest rate (ARM). A fixed interest rate will stay constant over the life of the loan (typically 15-30 years). Whereas an ARM stays fixed, at a relatively low rate for a short time, and then goes through an adjustment period — where the loan is recalculated at the lender’s going rate. The advantage of an ARM is that some borrowers, who may not qualify for a typical loan, may qualify for a loan through an ARM mortgage process.
With this type of loan, a borrower assumes more of the risk and can end up with a substantially higher interest rate that can make a monthly payment difficult. Be sure to mind your due diligence regarding any penalties if you pay off the loan prematurely.
2. How do I qualify for a conventional mortgage loan?
There are many factors to determining your qualification of a conventional mortgage loan, but the most important is credit score. The score you need can vary from lender to lender, but typically a minimum score of 620 is needed to qualify for a conventional mortgage.
If you want a better interest rate, a minimum credit score of 740 is generally required. Often times, with a conventional mortgage, you’ll need to bring to the mortgage financing table a down payment of at least 20%. Some lenders will let you get away with 5% down, but those are few and far between, and often come with the extra burden of mortgage insurance and other additional costs.
You will also need to save up some extra cash for the closing costs; tThough sometimes you can ask for the seller to pay the closing costs.
3. How long is a conventional mortgage loan?
This is probably the most misunderstood aspect of mortgage lending, as many people think that conventional mortgage means a 30-year loan. Again, “conventional” refers to the fact that the government is not guaranteeing the loan, not how long the mortgage is.
That being said, the two most common term lengths for conventional mortgages are 15-year and 30-year versions. Typically with a 30-year mortgage, you’ll have lower payments and no prepayment penalties; downside being a good portion of your payments will go toward interest. (Not always a bad thing; depends on the situation.)
With a 15-year conventional mortgage you’ll pay less interest over time, and own your house outright quicker. The downside is you’ll have higher monthly payments. There are, of course, other mortgage lengths — such as 10-year or even 40-year — but these are unusual.
4. How much do I need to earn to qualify for a conventional mortgage?
It’s not so much how much you earn, but something called a debt-to-income ratio. You could make a million dollars a year, but if you have $750,000 in debt, finding a conventional mortgage lender might not come so easily.
Surprisingly, part of the equation is dependent on where you live. Property taxes, mortgage insurance, lending rates and HOAs can all vary depending on where you plan on purchasing your home.
But as a general rule, you want to make sure that no more than 36% of your total monthly income is going toward your debt PLUS the cost of the mortgage. Yes, there are instances where you can get loan with a debt-to-income ratio as high as 43%, but this is quite rare.
4. Can I switch jobs or open new lines of credit before getting a conventional mortgage?
We won’t say you “can’t” get a mortgage if you’ve changed jobs recently or opened a new credit card — or even acquired a new loan. But doing any of the following can delay the mortgage lending process, which can put you back months, or even cause you to lose your dream home.
The key it so to limit your credit card spending, and avoid making large purchases so close to your mortgage financing quest. (Buying that new car can wait until you’ve unpacked your boxes in your new house.)
5. How much will my monthly mortgage payment be?
This depends on four factors:
- The price of the home
- The total down payment
- The length of the mortgage
- The Annual interest rate
Many websites offer free calculators that can give you a quick idea of what your monthly mortgage payments will be. (Here’s a great one from Bankrate.)
Remember, though, that with an ARM, or adjustable mortgage, that number may (and often will) change. It’s vital, if you do take out a conventional ARM mortgage, that you stay on top of your payments, and understand precisely where you are in your payment schedule. (There are times when you can refinance to a new ARM conventional loan.)
Also, be aware that in the first stage of your payback, much of your payments will go to paying off items such as interest, mortgage insurance, property taxes and sometimes HOA fees, with a much smaller portion earmarked for principal payment.
Knowledge is Power
Mortgage lending can seem a daunting subject at first, but now you’re armed with the basics. You’ve delved into how your mortgage payment is calculated, mortgage financing and the steps you need to take to be financially prepared to purchase a home.
The key is to acquire as much information as possible, even more information than you think is required, and take the steps necessary to secure the property that you want. (Whether through a conventional mortgage or other means.)
Knowing what you bring to the table as a borrower will put you in that most envious and powerful position of them all: a person who knows what a mortgage is, and what it can do for their financial future.