Conventional Loans: Why They Are Ideal For Borrowers With Good Credit And Stable Incomes

Conventional loans are the most common type of mortgage loans issued in the United States. They make up about 70% of the mortgage market and are provided by private lenders like banks, credit unions, and mortgage companies. Conventional loans are ideal options for borrowers who have good credit scores and stable incomes Here is a detailed look at why conventional loans work well for these types of borrowers

What Are Conventional Loans?

Conventional loans are mortgages that conform to the underwriting guidelines set by Fannie Mae and Freddie Mac. This means they meet certain standards for down payment amounts, loan limits, and borrower eligibility. Unlike government-backed loans from the FHA, VA, or USDA conventional loans are not insured or guaranteed by any government entity.

The advantages of conventional loans include:

• Lower interest rates – They offer some of the lowest rates available since they can be sold to investors

• Less red tape – Conventional loans often have an easier approval process than government loans.

• Higher loan limits – Loan limits for conforming conventional loans in 2023 are up to $726,200 in most areas.

• Flexible qualification requirements – Lenders set their own debt-to-income and credit score requirements within general guidelines.

Conventional Loan Eligibility

To qualify for a conventional loan, you’ll generally need:

• A minimum credit score of 620, although many lenders require 640 or higher. The average approved score for conventional loans is about 750.

• A debt-to-income ratio below 45%, although 36% or less is preferable.

• Sufficient income and assets to qualify based on the lender’s standards.

• A down payment of at least 3% for a primary residence. You can qualify for a conventional 97 loan with 3% down for a primary residence.

• 20% down payment if you want to avoid private mortgage insurance (PMI).

Conventional loans are ideal for borrowers who have good or excellent credit, moderate or high income, and minimal debt. Here are some examples of borrowers well-suited for conventional loans:

• First-time homebuyers with credit scores above 700 and steady W-2 income from employment. The ability to provide 3-20% down and funds for closing costs.

• Move-up homebuyers with high credit scores and enough equity from a prior home sale to make a down payment of 20% or more.

• High-income professionals and households with excellent credit and money saved for a down payment on a more expensive home. Low debt and high discretionary income.

• Self-employed borrowers with several years of consistent income on tax returns. High credit scores help offset the higher risk of self-employment income.

• Retirees or others with substantial assets but little or no monthly income. Funds to make a large down payment without financing 100% of the home’s value.

Benefits Of Conventional Loans For Qualified Borrowers

Low Interest Rates

Conventional mortgage rates are competitive, often among the lowest available. On a $300,000 loan amount, a borrower with a 740 credit score could expect total interest paid over 30 years of around $225,000 with a conventional loan at a 5% rate versus $270,000 on a 5.5% FHA loan. The better rate saves $45,000 in interest.

Smaller Down Payments

Conventional 97 loans allow down payments as low as 3% for buyers with good credit. This greatly expands homeownership opportunities compared to the 20% down previously required. Less cash is needed upfront to buy.

No Usage Restrictions

Conventional loans can be used to purchase single-family homes, townhomes, condos and even vacation properties or investment properties. Government loans like VA and USDA loans can only be used for primary residences.

No Mortgage Insurance

Borrowers who make down payments of 20% or more avoid paying private mortgage insurance with a conventional loan. With only 5% down, an FHA loan requires uppaid mortgage insurance for the life of the loan.

Lower Monthly Costs

With a 20% down conventional loan, borrowers get a lower monthly payment than a 5% down FHA loan because they don’t have mortgage insurance premiums. This provides more room in their budget.

Preserves Low Down Payment Options

FHA, USDA, and VA loans allow very low down payments but are limited to certain borrowers. Conventional 97 loans open low down payment mortgages to buyers with good credit who earn above the income caps on government loans.

Quicker Approvals

Conventional loans often involve less paperwork and faster processing times than government loans, especially for borrowers with simple finances. Closing can happen more quickly.

High Loan Limits

In expensive real estate markets, the maximum loan amount for a conforming conventional loan is higher than what FHA allows. Conventional loans go up to $726,200 while FHA loans are capped at $420,680.

Tips For Getting Approved For A Conventional Loan

If you want to get a conventional mortgage, here are some tips that can help ensure your approval:

• Aim for a 740 credit score or higher – This will qualify you for the very best rates and terms. Pay down balances, dispute errors to push your score higher.

• Keep your debt-to-income ratio below 36% – Lenders will want to see your total monthly debt including the new mortgage payment is less than 36% of your gross monthly income.

• Save for a down payment of at least 5% – Putting down 20% avoids PMI but 5% down still allows you to qualify and keeps your monthly payment reasonable.

• Reduce debt before applying – Pay off credit cards, auto loans, student loans, and other debts to lower your DTI. Close unused credit cards.

• Get preapproved – Being preapproved gives you a major advantage over putting in offers subject to financing. It shows sellers you are a serious buyer able to obtain financing quickly.

• Review your credit report – Make sure there are no errors dragging down your score and that you have an acceptable mix of credit types in good standing.

• Document assets and income – Have bank statements, tax returns, W-2s, and paystubs ready to support the income and assets stated on your application.

• Shop with multiple lenders – Compare interest rates and fees to find the most competitive conventional loan offers. Apply with the lender providing the best deal.

Alternatives To Conventional Loans

For borrowers who don’t qualify for a conventional loan, alternatives to consider include:

• FHA loans – Require just a 580 credit score and 3.5% down payment. Ideal for borrowers with fair credit or limited savings.

• VA loans – Offer 100% financing options for veterans and service members. Can be used with lower credit scores.

• USDA loans – Provide 100% financing in eligible rural areas. Have income limits borrowers must fall under.

• Subprime loans – Higher interest rate loans from specialized lenders that take on riskier borrowers who don’t conform to mainstream underwriting standards.

• Portfolio loans – Non-conforming jumbo loans or other specialized programs offered by banks and lenders to hold in their own portfolio rather than sell to investors on the secondary market.

• Down payment assistance programs – State and local programs provide grants, loans, or secondary financing to cover borrower’s down payments and closing costs when affordability is a concern.

The Bottom Line

Conventional loans offer homebuyers with good credit and financial profiles lower interest rates and solid financing options. For borrowers who can qualify, conventional loans are typically the best and most affordable choice when buying a home. They provide an ideal balance of low rates, lenient qualification guidelines, and flexible usage.

With conventional loans readily available, buyers don’t have to settle for higher cost government-backed loans or subprime lending. Conventional financing places homeownership within reach for millions of creditworthy borrowers. They smooth the path to buying your dream home.