Nothing compares to scrolling through listings until you find the home with the perfect garden, garage, and floors. Then comes the less fun part: figuring out how to finance your home purchase.
For the vast majority of people, acquiring a new home means taking out a mortgage, a loan for the part of the house cost that isn’t covered by the down payment.
U.S. homeownership hovers near 66%, and millennials continue to be the biggest share of buyers. What kind of loan do most go for? The 30-year fixed-rate mortgage. But conventional loan requirements vary, and some may find that a government-sponsored loan is a better fit.
Let’s take a closer look at conventional loan requirements and the difference between FHA and conventional loans.
Conventional Mortgages Explained
Conventional mortgages are insured by private lenders, not a government agency, and are the most common type of home loan.
Then there are government-guaranteed home loans. FHA loans are more commonly used than VA loans (for service members, veterans, and eligible surviving spouses) and USDA loans (rural housing). Government loans are often easier to qualify for.
Taking out a conventional home loan means that you are making an agreement with a lender to pay back what you borrowed, with interest.
And unlike with an FHA loan, the government does not offer any assurances to the lender that you will pay back that loan. That’s why lenders look at things like your credit score and down payment when deciding whether to offer you a conventional mortgage and at what rate.
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Two Main Types of Conventional Loans
A conventional loan with a fixed interest rate is one in which the rate won’t change over the life of the loan. If you have a “fully amortized conventional loan,” your monthly principal and interest payment will stay the same each month.
Although fixed-rate loans can provide predictability when it comes to payments, they may initially have higher interest rates than adjustable-rate mortgages.
Fixed-rate conventional loans can be a great option for homebuyers during periods of low rates because they can lock in a rate and it won’t rise, even decades from now.
Adjustable-rate mortgages have the same interest rate for a set period of time, and then the rate will adjust for the rest of the loan term.
The major upside to choosing an ARM is that the initial rate is usually set below prevailing interest rates and remains constant for six months to 10 years.
A 7/6 ARM of 30 years will have a fixed rate for the first seven years, and then the rate will adjust once every six months over the remaining 23 years. A 5/1 ARM will have a fixed rate for five years, followed by a variable rate that adjusts every year.
An ARM may be a good option if you’re not planning on staying in the home long term. The downside, of course, is that if you are, your interest rate could end up higher than you want it to be.
Most adjustable-rate conventional mortgages have limits on how much the interest rate can increase over time. These caps protect a borrower from facing an unexpectedly steep rate hike.
Conventional Home Loan Requirements
Conventional mortgage requirements vary by lender, but almost all private lenders will require you to have a cash down payment, a good credit score, and sufficient income to make the monthly payments.
Many lenders that offer conventional loans require that you have enough cash to make a decent down payment. Even if you can manage it, is 20% down always best? It might be more beneficial to put down less than 20% on your dream house.
You’ll also need to demonstrate a good credit history. For example, you’ll want to show that you make loan payments on time every month.
Each conventional loan lender sets its own requirements when it comes to credit scores, but generally, the higher your credit score, the easier it will be to secure a conventional mortgage at a competitive interest rate.
Most lenders will require you to show that you have a sufficient monthly income to meet the mortgage payments. They will also require information about your employment and bank accounts.
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How Do FHA and Conventional Loans Differ?
One of the main differences between FHA loans and conventional loans is that the latter are not insured by a federal agency.
FHA loans are insured by the Federal Housing Administration, so lenders take on less risk. If a borrower defaults, the FHA will help the lender recoup some of the lost costs.
FHA loans are easier to qualify for, and are geared toward lower- and middle-income homebuyers. They require at least 3.5% down.
Additionally, the loans are limited to a certain amount of money, depending on the geographic location of the house you’re buying. The lender administering the FHA loan can impose its own requirements as well.
An FHA loan can be a good option for a buyer with a lower credit score, but it also will require a more rigorous home appraisal and possibly a longer approval process than a conventional loan.
Conventional loans require private mortgage insurance if the down payment is less than 20%, but PMI will automatically terminate when the loan balance reaches 78% of the original value of the mortgaged property, unless the borrower asked to stop paying PMI once the balance reached 80% of the original property value.
FHA loans require mortgage insurance, no matter the down payment amount, and it cannot be canceled unless you refinance into a conventional loan.
Recommended: Guide to Buying, Selling, and Updating Your Home
A conventional home loan and FHA loan differ in key ways, such as credit score requirements. If you’re ready to make your dream house a reality, you’ll want to size up your eligibility and your mortgage options.
SoFi offers fixed-rate home loans with as little as 5% down and terms of 10, 15, 20, and 30 years.
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