What are the Basic Requirements for a Conventional Loan {2021}

The requirements for securing a conventional loan vary with the lending institution. Banks usually have stricter requirements than finance companies, but the interest rates charged by banks are generally lower than those charged by other lenders. 

The rates and requirements also depend on the type of loan requested. Secured loans have lower requirements than unsecured loans.

Conventional Loan Requirements

conventional loan vs FHA

What are the basic Requirements for a Conventional Loan? See below for details: –

  • Cash Secured Loan

It may be possible to get a secured loan from a bank with no credit history if the security for the loan is a cash deposit. Borrowers are required to have a steady source of income that is sufficient to cover the loan payments. 

Cash secured loans are a good way for people without a credit history to build or rebuild credit. Other types of secured loans include car loans and home mortgages, but these can be more difficult to get since the lender faces a greater risk of loss on the investment.

  • Job History and Income

For most conventional loans, borrowers must have kept the same job for at least two years. While this may not be required for cash secured loans, it is required for other types of loans. Minimum income conventional loan requirements depend on the lending institution and the amount of the loan, but most lending institutions require an income of at least $800 per month. 

Income from sources other than employment may be considered if the income is derived from a stable source like annuities, disability payments or social security.

  • Credit History

Although a great deal of attention is given to credit scores, credit history is a more important consideration for many lenders. A good credit history will show the timely payment of obligations, including utility bills, medical bills, credit card bills and loan payments. 

A history of late or missed payments can cause a lender to decline a loan since even if an individual meets all other conventional loan requirements. Individuals who have a minimum qualifying credit score may be able to get a loan if their credit history is good.

  • Credit Scores

Most lending institutions use an average of credit scores from three credit reporting agencies. The minimum average credit score for most types of conventional loans is 620. 

Credit scores are based on an individual’s borrowing and repayment habits and include loans, credit cards, cell phone bills, medical bills and utility bills. If a person pays all their bills on time and does not borrow any money, his or her credit score may not meet minimum conventional loan requirements.

  • Debt Ratio

The debt ratio is the amount of payments compared to the amount of income. In a FHA mortgage loan, for example, the debt ratio cannot exceed 29% of the income. This includes the loan payment, interest, taxes and insurance. 

The total debt ratio cannot exceed 41% and this would include car payments, student loan payments, credit card debt and personal loans. The acceptable debt ratio depends on the lending institution and the amount and type of loan requested.

Conventional loan requirements are intended to protect both lenders and borrowers. The recent recession has highlighted the need to enforce minimum loan requirements to prevent individuals from borrowing more money than they can reasonably repay.

Conventional Home Loan Down Payment Requirements

The requirements for home loans vary substantially between lenders, but all lenders consider credit scores, debt ratios, income, job and credit histories, and down payments. 

The amount of the requested loan can affect other minimum requirements since loans for higher amounts may require higher credit scores and income, and lower debt ratios.

  • Down Payments

Lending institutions vary in their down payment requirements, but for conventional loans a minimum of a 5% down payment is almost always required. Some institutions may require a 10% down payment for a fixed rate 30-year mortgage loan. Individuals with higher down payment amounts may have lower income and credit score requirements to obtain the loan. 

While a credit score of 720 may be required with a 10% down payment, a credit score of 620 may be sufficient to obtain the loan with a 20% down payment.

  • Debt Ratio and Income

Generally, the debt ratio of a mortgage payment, including insurance and taxes, cannot exceed 30% of the monthly income. When combined with other outstanding debt, the debt ratio of payments to income cannot be more than 45%. This includes obligations like student loans, credit card debt, car loans and personal debt. 

Recurring bills like utilities and cell phones are usually not included when determining the debt ratio. Medical debt may or may not be included in this figure depending on the policies of the lender.

  • Job History and Income

Most lenders offering conventional loans require that an individual be with the same employer for at least two years prior to the loan application. 

Some lenders may consider applicants who have been with an employer less than two years if they are working in the same type of position for the same salary, or a higher salary, or if they had previously been with a single employer for more than three years. A stable job history is pre-requisite for lenders when applying for a conventional loan.

  • Credit Scores

While the median required credit scores vary between lenders, most lenders will not finance conventional loans for individuals with a credit score of less than 620. Bank requirements may be higher than those of mortgage or finance companies, but conventional lenders usually will not consider credit scores below the 620 mark. 

This is the minimum requirement for government insured loans (FHA) and in the wake of the recent mortgage crisis, lenders have raised their requirements to meet or exceed government minimum requirements.

  • Credit History

While credit scores reflect a person’s current credit status, the credit history looks at the pattern of borrowing and repayment for a period of 7 to 10 years. Previous bankruptcies, foreclosures, repossessions and late payments can impact a lender’s decision. 

If any of these financial problems occurred within five years of the loan application, they may be grounds for the lender to refuse the loan. Borrowers with at least five years of good credit history are usually approved for a conventional mortgage loan.

Requirements, while they may vary between lenders, are always based on these criteria. The requirements for FHA, HUD, VA and other types of unconventional mortgage loans, like adjustable rate loans, are different from the requirements for conventional mortgages.

Conventional Loan Credit Score Requirements

The credit score requirements for conventional loans vary depending on the lender, the type of loan and, in the case of mortgages, amount of the down payment. Most conventional loans require a minimum median credit score of between 620 and 720. The scores are obtained from three credit reporting bureaus.

What is a Median Credit Score?

Most lending institutions request credit scores from the three major reporting bureaus, Equifax, Experian and TransUnion. The different bureaus have different methods for calculating their scores and they can vary by 20 points or more. 

Lenders discount the high and low scores and use the middle, or median, score to determine eligibility for a loan. Most conventional lenders require a minimum median score of 620, but some lenders may have higher or lower credit score requirements depending on other factors.

Down Payments and Credit Score Requirements

individuals who are seeking a mortgage loan usually need a minimum credit score of 720 if their down payment is 10%. With a down payment of 20%, the minimum required credit score may be as low as 620. As a rule, the credit score requirements of banks are higher than those of other types of lenders. 

The interest rates charged by banks are usually lower than those charged by other lenders which make bank loans more attractive to borrowers. Individuals may be able to raise their median credit score by 20 points in a short period of time.

Correcting Errors in Credit Reports

A low credit score may be caused by a reporting error, so individuals seeking a loan should obtain copies of their credit reports to check for errors or disputed debts. 

If a lender incorrectly reported payments or failed to report that a debt was paid, the person can contact them to request the error be corrected. If a person disputes a debt, he or she can report that debt as disputed to the credit bureaus. Clearing errors from the credit report can raise an individual’s median credit score quickly.

Raising Credit Scores

One of the factors used in calculating a credit score is the debt to income ratio. By paying down the amount of existing debt, an individual can raise their median credit score almost immediately. 

Most people do not realize that when lenders request credit reports it can have an adverse effect on their credit score. Trying to get a loan from several lenders at the same time can actually lower a credit score by more than 20 points. Never apply for credit from more than one lender at a time.

Other Reasons for Low Credit Scores

People who are financially responsible but do not borrow money or use credit cards usually have low credit scores. In order to establish a good credit score, it is necessary to borrow money. Those who choose to live within their means can establish a credit score by obtaining a secured loan or by using a secured credit card. 

A debit card does not report to credit bureaus and does not improve credit scores. A secured credit card requires a cash deposit for the credit limit of the card and credit card companies make regular reports to credit bureaus.

Before seeking a loan, borrowers should check their credit reports and take the necessary steps to meet the minimum credit score requirements. Credit bureaus are required to provide a free copy of an individual’s credit report upon request. 

Requesting a copy of their own credit report does not have any effect on a person’s credit score.

Calculating Conventional Loan

Many people are not sure how much they can afford to spend when buying a house. Those seeking a conventional mortgage can determine the amount of the loan they can be approved for by calculating the amount of money they have for a down payment.

  • 5% Down Payment

The minimum down payment for a 15- or 30-year fixed rate mortgage is 5% of the value of the home. If the list price of the home is $100,000, buyers should have at least a $5000 down payment. There are other expenses when buying a home, like closing costs, which can amount to as much as $5000. 

In some cases, the seller will agree to pay all the closing costs and simply add them in to the price of the home allowing the buyer to basically finance these costs.

  • 10% Down Payment

While a 10% down payment may not be required, a higher down payment can help buyers qualify for a conventional mortgage. Lower monthly payments mean that buyers need less income to pay the loan and income is a factor when applying for a home loan. 

Down payments of 5% or 10% require buyers to pay PMI (private mortgage insurance) premiums. PMI does not offer any advantage to the borrower and is solely for the benefit of the lender.

  • 20% Down Payment

Buyers who can make a down payment of 20% or more do not have to pay PMI and often have lower requirements for loan approval than buyers with smaller down payments. It is often easier to buy a less expensive house with a large down payment than to buy a more expensive property with a small down payment. 

A large down payment reduces the debt to income ratio by reducing the amount of the loan and most lenders require lower credit scores for buyers who have down payments of 20% or more.

  • Government Insured Loan Down Payments

Most Americans are familiar with FHA and VA mortgage loans which usually have lower requirements than conventional home loans. FHA and VA insured mortgages require a down payment of 3%. 

While buyers may believe they need less money to purchase a home with a government insured loan, closing costs for these loans are usually higher than those for conventional loans. Both the buyer and the seller are required to pay points at closing and some sellers will not accept FHA or VA financing.

  • Adjustable Rate Mortgage Down Payments

Adjustable rate mortgages (ARM) are not conventional mortgages. The payments are not fixed and usually increase over time as interest rates increase. 

Lending institutions which offer conventional loans may offer an ARM to a home buyer who does not qualify for a conventional mortgage because their down payment is too small. Buyers with higher down payments whose credit score or debt to income ratio disqualifies them for a conventional mortgage may qualify for an ARM.

While credit institutions require a down payment of at least 5% for a conventional loan, home buyers with more money for a down payment often have a better chance of obtaining financing. 

Unconventional home loans like ARMs have pitfalls, so buyers should understand their options when seeking financing for a home.

Conventional Loan Vs FHA Loans

FHA is the acronym for Federal Housing Authority which insures mortgage loans made by lenders to qualifying home buyers. 

The requirements for FHA loans may be different from those of conventional loans and HUD, the agency that insures the loans, places certain restrictions on the types of property that can be purchased.

Qualifying for an FHA Loan

Requirements for an FHA loan include a minimum credit score of 620, and a debt to income ratio of 29% for the home loan and no more than 41% for all outstanding debt. Income for the two-year period prior to applying for the loan must be verified and any gap in income or employment must be explained. 

Frequent job changes are not considered favorably unless the changes resulted in an increase in income. Seasonal employment does not automatically disqualify an applicant if sufficient annual income is earned.

Finding a Qualifying Property

The FHA has strict rules for the property that is being purchased, and not all properties can qualify for FHA approval. All major systems must be functional and there cannot be an active termite infestation or existing termite damage. 

Lead paint in homes built before 1978 must be removed or sealed and well and septic systems must meet FHA standards. The requirements for buildings under conventional loans are usually less stringent than FHA regulations.

Advantages of FHA Loans

It is easier for most people to qualify for an FHA loan than for a conventional loan. The required down payment for an FHA loan is about 3.5% and the buyer may cover the down payment with a loan or a gift from a relative or charitable organization. 

Most conventional lenders require that the buyer have the money for the down payment in an account and the buyer usually is required to have at least 10% down payment to qualify for a conventional loan.

Disadvantages of FHA Loans

FHA loans often have higher closing costs than conventional mortgage loans and buyers must pay a onetime fee of 1% of the price of the home for mortgage insurance. A small fee for mortgage insurance is also added to the monthly payments. 

While conventional loans require buyers with a down payment of less than 20% to pay private mortgage insurance, the cost of PMI is usually lower than the rates charged by FHA. Since FHA does require the seller to pay some closing costs, there are sellers who will not accept FHA financing.

Conventional Mortgage vs. FHA Interest Rates

Home buyers with good to excellent credit usually get lower interest rates on conventional loans than on FHA loans. FHA rates are higher than conventional mortgage interest rates for most buyers who can qualify for a conventional mortgage. 

FHA has less stringent credit requirements so individuals who cannot qualify for a conventional mortgage often do qualify for an FHA loan. FHA loans do not have prepayment penalties that are charged for conventional mortgage loans.

Conventional mortgage loans have some advantages over FHA loans, but they are much harder to qualify for and require a larger down payment. 

FHA loans are easier to get and have a minimal down payment, but take longer to close and have higher closing costs. Most buyers who are able to qualify for a conventional mortgage can save on fees and interest over an FHA loan.

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