Think back to a time when you made a major purchase; maybe it was a car or some new appliances. You may have financed your purchase through the dealer or retailer, and it was probably a pretty straightforward process. You can show up unannounced at a car dealership in the morning and be leaving with a financed new car purchase by lunchtime. The same is definitely not true for mortgage financing. In certain situations, the process may only take a couple of weeks, but many purchase contracts allow for a month or more for the loan process to complete. And when you financed your car, there probably weren’t many choices as to which type of financing you used. You probably picked the term and interest rate but not much more than that.
In the mortgage world, there are many types of loans available, each with specific requirements, known in the mortgage industry as guidelines. There is no one-size-fits-all when it comes to mortgages and having a variety of programs available allows a lender to find the most suitable program for each borrower. Over the next few months, we’ll cover some of the loan programs available and why a borrower may choose one over another.
When most people think of a mortgage, they think of a conventional mortgage. Simply put, a conventional mortgage is not offered or secured by a government entity. These are available through banks, credit unions, and mortgage lenders. Because they aren’t secured by a government entity, a conventional loan tends to have stricter requirements than a loan secured by a government entity. Some conventional loans, however, can be guaranteed by one of two government-sponsored enterprises (Fannie Mae and Freddie Mac). Qualifying requirements for these include minimums for the applicant’s credit score and debt-to-income ratio, among others.
If later, a lender wishes to sell a conventional loan to Fannie Mae or Freddie Mac, that loan must also be, what’s known as, “conforming,” meaning it conforms to the guidelines of those government-sponsored enterprises. For example, one of the conforming guidelines is the maximum loan limit. The conforming loan limit for 2021 is $548,250. (There are exceptions to this amount in higher cost geographic areas.) Why would a lender sell their loan to Fannie Mae or Freddie Mac, you ask? A lender only has a finite amount of money to lend. By selling a loan on the secondary market (such as to Fannie Mae or Freddie Mac), the lender is able to replenish their own finances to be able to offer more loans. The secondary market plays a critical role in ensuring a flow of funds to mortgage lenders.
A conventional loan also requires a down payment which can be as little as 3% for qualified borrowers. However, if a borrower puts less than 20% down, the lender can require the purchase of private mortgage insurance (PMI). Plus, a lower down payment may require a higher credit score. Generally, the minimum credit score for a conventional loan is 620. Conventional guidelines will also dictate what kind of documentation a lender must collect from the borrower, e.g. W2s, tax returns, pay stubs, bank statements, and more. The guidelines also specify which type of appraisal may be necessary.
When a bank or loan officer receives an application for a loan, it is usually submitted through an automatic underwriting system which helps determine if the loan will qualify for conventional financing and specify exactly what documentation may be required.
Conventional mortgages are very common, but they aren’t the only option out there. Next month, we’ll examine FHA mortgages and their critical role in the mortgage lending industry.