What is a Conventional Mortgage and What Homebuyers Need to Know

A conventional mortgage is a home loan not insured or guaranteed by a government agency, such as the Federal Housing Administration or the Department of Veterans Affairs. Instead, it is issued by a private lender, such as a bank or credit union, based on the borrower’s creditworthiness and ability to repay the loan.

Creditworthiness

Since conventional mortgages are based on a borrower’s creditworthiness, it’s important to have a good credit score to qualify for the best rates and terms. Homebuyers should aim for a credit score of at least 620, although some lenders may require higher scores.

A credit score is a numerical representation of a borrower’s creditworthiness based on their credit history, including payment history, credit utilization, and length of credit history. A good credit score can help homebuyers qualify for lower interest rates and better terms on their mortgage.

Down Payment

Unlike government-insured mortgages, conventional mortgages typically require a larger down payment. A down payment of at least 20% is ideal, as it can help avoid the need for private mortgage insurance (PMI) and lower monthly payments.

A down payment is the money a borrower pays upfront when purchasing a home. This amount is subtracted from the total purchase price, and the remaining balance is financed through a mortgage. A larger down payment can reduce the interest over time and help borrowers build home equity more quickly.

Debt-to-Income Ratio

Lenders will also consider a borrower’s debt-to-income ratio (DTI) when evaluating their eligibility for a conventional mortgage. This ratio compares the amount of debt a borrower has to their income. A lower DTI ratio is generally more favorable to lenders, as it suggests a borrower has a better ability to repay the loan.

A DTI ratio calculates a borrower’s total monthly debt payments by their gross monthly income. Lenders typically prefer a DTI ratio of 36% or lower, although some may be willing to approve loans with higher ratios if other factors, such as a high credit score, are present.

Interest Rates

Conventional mortgage rates can vary depending on market conditions and the borrower’s creditworthiness. Homebuyers should shop around and compare rates from multiple lenders to find the best deal.

Interest rates are the amount of money a borrower pays in addition to the principal loan amount for the privilege of borrowing money. Lower interest rates can result in lower monthly payments and less interest over time. Homebuyers should compare interest rates from multiple lenders to ensure they get the best deal possible.

Loan Terms

Conventional mortgages typically come with various loan terms, ranging from 10 to 30 years. Longer loan terms can lead to lower monthly payments but may increase interest charges.

Loan terms refer to the length of time a borrower has to repay their mortgage. A longer loan term can result in lower monthly payments but may also result in higher interest charges over time. Homebuyers should carefully consider their budget and financial goals when selecting a loan term.

By keeping these important takeaways in mind, homebuyers can make informed decisions when considering a conventional mortgage.

If you have questions or comments, please contact Jonathan Baer.