If you plan to buy a home this year, it’s a good time to take stock of what type of mortgages are available and understand conventional home loan requirements. The conventional home loan is often thought of as a “regular” mortgage. It’s not a government-backed loan — although it might be sold to and serviced by the government-sponsored companies Fannie Mae and Freddie Mac. As you begin shopping for a home, it’s essential to understand what the requirements are to qualify for a conventional home loan.
Who Qualifies for a Conventional Loan?
While there are standardized underwriting guidelines for conventional home loans, many mortgage lenders overlay unique requirements in addition to Fannie Mae and Freddie Mac guidelines. In general, each lender will have its own mortgage lending protocol and accepted practices. However, there are some guidelines you can follow that may help improve your chances of getting approved. You need to prove your ability to pay back the loan, which includes meeting income requirements and credit score criteria.
The underwriting guidelines for conventional loans vary by lender, but here some things you need to know about how to qualify for a conventional home loan.
Down Payment Requirements for a Conventional Loan
Your down payment can make a difference in how much you end up borrowing and what the interest rate will be for your loan. The bigger your down payment, the less debt you’ll acquire — and the better your chance of getting the best possible mortgage rate.
Conventional loan down payment requirements vary by lender, but, in general, it’s possible to get a conventional mortgage with 5% down. Some lenders are even starting to offer conventional loans to buyers who qualify with less than 5% down. While it’s possible to find lenders willing to accept a lower down payment, homebuyers will usually need to qualify for a special government-backed homebuying program such as an FHA loan (3.5% down) or USDA loan (0% down) to get a lower down payment.
While you can get a conventional mortgage with as little as 3% down, some lenders may prefer you to have at least 10% to put toward a down payment. If you have less than 20% for a down payment, you’ll likely have to pay private mortgage insurance (PMI) with a conventional loan. PMI can raise your monthly mortgage payment by $100 or more.
Credit Score Requirements for a Conventional Loan
The conventional loan credit score isn’t set in stone. However, most lenders prefer to see a minimum credit score for a conventional loan of 620. If you have a credit score at that level, however, you might not qualify for the best mortgage rates. If you want to be considered for the lowest possible mortgage rates, you might need an “excellent” score of at least 740.
Depending on how you’re meeting other conventional home loan qualifications, you might be able to get better terms with a lower credit score. For example, if you have a higher down payment for your conventional loan, or if you can prove a high income, your credit score might not be as important when lenders compare your financial information with their underwriting guidelines for conventional loans.
Income Requirements for a Conventional Home Loan
When it comes to meeting conventional loan income requirements, it’s not about having a certain amount of money in your paycheck or banking account. Instead, it’s about using underwriting guidelines, including your debt-to-income ratio (DTI), to figure out if you earn enough income to comfortably handle your monthly mortgage payments.
Rather than focusing on a specific amount of income, a lender is likely to look at whether you can prove that your income is stable and that you’ll be able to make payments. Many lenders turn to Fannie Mae’s underwriting and documentation guidelines for conventional loans because a loan that adheres to these guidelines has an increased chance of Fannie Mae or Freddie Mac buying the loan later.
Some of the documentation needed to show you meet conventional loan income requirements include:
- W-2 forms
- Recent tax returns
- Business tax returns
- The completion of Fannie Mae’s Cash Flow Analysis form
- Verbal verification of employment from your employer
There are also types of non-employment income, such as child support, capital gains and royalty payments that qualify to meet Fannie Mae and Freddie Mac’s income guidelines for conventional loans. In fact, there are more than 20 items on the list of non-employment income that qualifies.
As long as you have the documentation to back up your income claims, you have a better chance of being approved for a conventional home loan.
Debt-to-Income Ratio for Conventional Mortgages
While the conventional home loan requirements for income are used to show that you have earning stability, the debt-to-income (DTI) ratio relies on debt and income data to determine if you qualify. Your DTI is a measure of how much of your monthly income goes toward debt payments, and it’s pretty easy to calculate.
Most conventional home loan qualifications require a DTI lower than 49%. Fannie Mae’s guidelines, in general, prefer a DTI cap of 36% to 45%. However, in some circumstances, such as borrowers having a bigger reserve of cash and a high credit score or debts that will be paid off within a few months, underwriting guidelines for conventional loans may go as high as 50%.
Some lenders may use what’s known as the 28/36 qualifying ratio. In this case, the DTI before the mortgage would need to be 28%, and once the mortgage payment is added, the DTI shouldn’t exceed 36%.
To meet those requirements, you might need to pay off some of your non-mortgage debt to reduce your monthly payments, look for a less expensive home, or speak with more than one lender to see what their DTI requirements are. Making a bigger down payment for your conventional loan might also help by lowering your monthly payment enough to bring your DTI down to an acceptable level. Use a mortgage calculator to get an idea of what to expect for a mortgage payment.
Do Conventional Loans Require Private Mortgage Insurance (PMI)?
When you get an FHA loan, you’re required to get mortgage insurance, except in some instances. But do conventional loans require PMI? In cases where your down payment is less than 20%, there’s a good chance your lender will require PMI.
There are some ways to avoid PMI even with a smaller down payment, but, typically, if you aren’t putting 20% down, you can expect to have PMI added to your monthly payment. The good news is that at some point, once your home reaches a certain value relative to your mortgage balance, the PMI payment can be removed.
Conventional Loan Rates in 2020
Mortgage rates are influenced by a variety of factors, including market conditions, 10-year Treasury yields, your ZIP code and your personal qualifications.
For example, as of January 2020, the average rate for a 30-year fixed conventional home loan is between 3.50% and 3.625%, according to Mortgage News Daily. However, the rate you’re offered might vary based on where you live, how much you intend to borrow, the size of your down payment and your credit score.
When looking for the best mortgage rates, it’s a good idea to shop around and compare offers. Additionally, it can make sense to get a guarantee from your lender that the rate they quote you will be good for at least 30 days, so you’re protected if mortgage rates rise. Many lenders will guarantee to honor a lower rate if conventional loan rates rise — and give you the lower rate if mortgage rates drop during that period.
Conventional Loan Limits
Conventional loan requirements in 2020 are different from those in 2019. Each year, the Financial Housing Finance Administration (FHFA) announces the conforming loan limits associated with conventional loans that can be bought by Fannie Mae and Freddie Mac.
While you might find lenders willing to provide a conventional mortgage amount that exceeds these limits, it can be difficult — especially if the financial institution wants to be able to sell the loan elsewhere. These conventional loan limits are known as conforming limits because they conform to the requirements needed to sell to Fannie Mae or Freddie Mac.
Conventional loan requirements for 2019 were $484,350. Conventional loan requirements for 2020, though, are $510,400, thanks to recent changes from the FHFA. Additionally, some high-cost areas have higher conforming loan limits. These limits are set based on local median home values, so before you start shopping for a home, it can make sense to find out the conforming loan limits in your area so that you know what to expect.
7 Steps to Qualify for a Conventional Mortgage Loan
When determining how to qualify for a conventional home loan, it’s important to plan ahead. A home is a big purchase, and if you want to increase the chances that you meet the conventional home loan qualifications, these steps can help.
Review Your Credit History
Start by taking a look at your credit history. Because your credit score is based on the information in your credit report, it’s important to make sure the information is accurate. The Consumer Financial Protection Bureau regularly sees complaints about inaccuracies, and a Federal Trade Commission report found that 26% of consumers have errors on their credit report that could negatively impact their financial outcomes.
Improve Your Credit Score
Your credit score is one of the first factors a lender looks at when considering you for a home loan. According to a New York Federal Reserve report from November 2019, 90% of borrowers who took mortgages during the first quarter of 2019 had a score of at least 650. If you want to boost your chances of being approved for a mortgage, a better credit score can help.
Save Up Your Down Payment
The higher your conventional loan down payment, the smaller your mortgage will be. Additionally, with a 20% down payment, you can avoid PMI. You’re also more likely to get a better mortgage rate. However, a 20% down payment isn’t necessary, and while many lenders offer a 5% conventional loan, some are starting to offer conventional loans with down payments as low at 3%.
Reduce Your DTI
Run the numbers to see how much of your monthly income is going toward debt payments. A good target for the best conventional home loan terms is the 28/36 qualifying ratio. However, if you want your conventional loan to conform to Fannie Mae and Freddie Mac, you need to aim to keep your total DTI to no more than 45%.
Document Your Assets
Depending on your situation, you might need to prove that you have an adequate financial reserve to cover mortgage payments. If you’re selling a home, this might be especially important. Additionally, if you have a high DTI, you might need to prove that you have investments and other assets that can sustain you during tough times.
Prove Your Income
Gather the necessary documentation to prove that you have a stable income. Not only do you need to show that your income is large enough to cover the monthly mortgage payment, but you also need to prove that your earnings are relatively stable. Gather pay stubs and tax return information so that you’re ready.
Consider Avoiding PMI
If you can swing a 20% down payment, this might be a good way to save money on your mortgage payment each month. Plus, that bigger down payment might mean a lower interest rate.
Finding the Best Lender
While a low mortgage rate is often an important consideration when choosing a home loan, it’s not the only thing to consider. Take a look at the closing costs associated with the loan and consider customer service. When comparing mortgage lenders, you should think of it like you’re comparing apples to apples.
Additionally, if you have a unique situation, you might need to consider a local financial institution that’s more likely to work with you on conventional home loan requirements. Here are some tips for finding the best lender:
- Look online for lenders that offer conventional home loans
- Ask your real estate agent for a recommendation
- Turn to friends, family and coworkers for their suggestions
- Contact your current bank to find out what they can do for you
- Read reviews from trusted resources like J.D. Power and the Better Business Bureau
You can also find out if a local lender will match the home loan offers and terms you find online. Figure out what matters most to you when it comes to your relationship with a lender. Realize that many conventional home loan originators will sell your loan to a different institution, and that will be the company that collects your payments and manages your customer service needs.
Finally, if you do your shopping around, do it in a short period. Your FICO score takes into account loan shopping, and if you have a lot of mortgage inquiries within a two-week period, they won’t each impact your score individually.
Key Facts About Qualifying for a Conventional Loan
As you shop for a mortgage in 2020, you’re more likely to succeed if you plan ahead and prepare for the process. Here’s how to get approved for a conventional mortgage:
- You don’t need a 20% down payment — there are 3%–5% conventional loan down payments available to qualified home buyers
- It helps to have a minimum credit score for a conventional loan of at least 620
- The better your credit score, the lower your mortgage rate
- Keep your DTI low to meet underwriting guidelines for conventional loans
- Be ready with documentation proving your income and its stability
If you can keep these guidelines in mind, there’s a good chance you’ll meet the conventional home loan qualifications and find a home you can afford and love.
About Miranda Marquit
- Consumer Financial Protection Bureau. " Consumer Response Annual Report." Accessed January 28, 2020.
- Fannie Mae. "Debt-to-Income Ratios." Accessed January 28, 2020.
- Fannie Mae. "Income and Employment Documentation for DUI." Accessed January 28, 2020.
- Federal Housing and Finance Agency. "FHFA Announces Maximum Conforming Loan Limits for 2020." Accessed January 28, 2020.
- Federal Trade Commission. "Report to Congress Under Section 319 of the Fair and Accurate Credit Transactions Act of 2003." Accessed January 28, 2020.
- Mortgage News Daily. "Mortgage Rates Tiptoe Near Multi-Year Lows." Accessed January 28, 2020.
- New York Federal Reserve. "Quarterly Report on Household Debt and Credit." Accessed January 28, 2020.
- U.S. Department of Housing and Urban Development. "Let FHA Loans Help You." Accessed January 28, 2020.
- U.S. Department of Agriculture. "Single-Family Housing Guaranteed Loan Program." Accessed January 28, 2020.