What is a conventional mortgage?
– Definition: A conventional mortgage is a home loan issued by a private lender (bank, credit union, or mortgage company) that is not directly insured by a federal agency. Some conventional loans may meet the purchase requirements of government‑sponsored enterprises (GSEs) — mainly Fannie Mae or Freddie Mac — but they are originated in the private market.
Key features (short)
– Origin: Private lenders, not a federal agency.
– Backing: May or may not meet Fannie Mae/Freddie Mac criteria.
– Interest: Available as fixed‑rate or adjustable‑rate (variable) loans.
– Credit & down payment: Typically stricter credit standards and larger down payments than government‑insured products.
Important distinctions and terms (definitions on first use)
– Down payment: The cash you pay up front toward the purchase price; reduces the loan amount.
– Government‑sponsored enterprise (GSE): A federally chartered company such as Fannie Mae or Freddie Mac that buys mortgages from lenders to provide liquidity.
– Conforming loan: A mortgage whose size and underwriting match the GSEs’ published limits and rules (for 2024, the baseline conforming limit in most U.S. counties is $766,550).
– Jumbo loan: A conventional mortgage whose size exceeds the conforming limit; it cannot be bought by Fannie Mae or Freddie Mac.
– Mortgage‑backed security (MBS): Pools of mortgages sold to investors; conventional loans are commonly packaged into pass‑through MBS.
– TBA (to‑be‑announced) market: The forward market where many agency MBS trade.
– CMO (collateralized mortgage obligation): A more complex form of MBS made by slicing pooled mortgages into tranches.
Why lenders treat conventional loans differently
– Because conventional loans lack direct federal insurance, lenders usually impose tighter credit, income, and asset checks compared with FHA, VA, or USDA programs. Loan pricing can also depend on credit score, down payment size, and whether the loan meets GSE conforming rules.
Types of conventional mortgages (brief)
– Fixed‑rate conventional: Interest rate stays the same for the loan term (common terms: 15, 20, 30 years).
– Adjustable‑rate conventional: Interest rate resets after a fixed introductory period according to an index plus a margin.
– Conforming conventional: Meets GSE loan limits and guidelines.
– Jumbo conventional: Loan amount exceeds the conforming limit.
Required documentation (short checklist)
– Mortgage application (fully completed; may require an application fee).
– Proof of income: Recent pay stubs, W‑2s, tax returns, 1099s (as applicable).
– Assets: Bank statements, retirement account statements, other liquid reserves to cover down payment and closing costs.
– Employment verification: Employer contact(s) or written verification of employment.
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– Credit report and authorization: Lender will pull one or more credit reports and scores (FICO or Vantage) and ask you to sign a credit authorization. Dispute errors early if you find them.
– Property appraisal: Independent appraiser verifies the market value; the lender uses the appraised value or sale price—whichever is lower—to calculate loan-to-value (LTV).
– Title search and title insurance: Confirms seller’s ownership and uncovers liens or encumbrances; title insurance protects lender (and optionally buyer) against future defects.
– Photo ID and Social Security number: Government ID and SSN for identity and tax reporting.
– Gift documentation (if applicable): Letter from donor specifying funds are a gift, not a loan, plus donor bank statements.
– Homeowner’s insurance binder: Proof you purchased hazard insurance effective at closing; lenders commonly require it.
– HOA documents (if applicable): Covenants, conditions, and restrictions (CC&Rs) and HOA financials if the property is in a homeowners association.
– Flood certification: Required in many loans to determine if flood insurance is necessary.
Underwriting basics (what lenders check)
– Loan‑to‑Value (LTV): LTV = loan amount ÷ lesser of appraised value or purchase price. LTV measures collateral coverage; lower is better. Example: purchase price $375,000, down payment $75,000 → loan = $300,000 → LTV = 300,000/375,000 = 80%.
– Debt‑to‑Income ratio (DTI): DTI = total monthly debt payments ÷ gross monthly income. Lenders use two ratios: front‑end (housing-only) and back‑end (all debt). Typical conforming limits vary but a back‑end DTI ≤ 43–45% is a common guideline. Example: gross income $6,000/month, existing debts $600/month, projected mortgage principal+interest = $1,347 → back‑end DTI = (600+1,347)/6,000 = 32.45%.
– Credit score and history: Higher scores generally get better rates and terms. Lenders examine payment history, credit utilization, account age, and recent credit inquiries.
– Reserves and assets: Some loans require cash reserves (months of mortgage payments) after closing; liquid assets support down payment and closing costs.
Private mortgage insurance (PMI)
– PMI is insurance that protects the lender when LTV > 80% (down payment < 20%). It can be paid monthly, annually, or as an upfront premium. Rules for cancellation differ by loan type; borrowers can request PMI removal when LTV reaches 80% by payment or appraisal.
Monthly mortgage payment formula (fixed‑rate)
– Standard formula for monthly principal & interest (PI):
M = P * r * (1 + r)^n / ((1 + r)^n − 1)
where M = monthly PI payment, P = loan principal, r = monthly interest rate (annual rate ÷ 12), n = number of payments (years × 12).
Worked example
– Scenario: Purchase price $375,000; down payment 20% ($75,000); loan P = $300,000; annual rate = 3.5%; term = 30 years.
r = 0.035/12 = 0.0029166667; n = 360.
(1 + r)^n ≈ 2.853. Plugging into formula gives M ≈ $1,347.13 per month (principal & interest).
Add estimated property tax ($300) and homeowners insurance ($100) to get a total housing payment ≈ $1,747.13/month.
Common fees and closing costs
– Origination fee, appraisal fee, credit report fee, underwriting fee, title and escrow fees, recording fees, prepaid interest, and escrow deposits for taxes and insurance. Expect roughly 2–5% of purchase price in closing costs (varies widely).
Step‑by‑step: applying for a conventional mortgage
1. Check your credit report and correct errors.
2. Calculate your budget (use LTV and DTI guidelines).
3. Gather
3. Gather required documents
– Pay stubs (last 30 days).
– W-2s (last 2 years) and recent federal tax returns if self‑employed.
– Bank and investment statements (last 2–3 months).
– Photo ID and Social Security number.
– Proof of additional income (rental, alimony, bonuses) and documentation for large deposits.
– Current mortgage statements or lease agreements (if renting).
– Gift letters (if part of your down payment).
Why: lenders use these to verify income, assets and liabilities. Missing items slow the process.
4. Get prequalified, then seek preapproval
– Prequalification: quick estimate from a lender based on self‑reported info. Good for home shopping.
– Preapproval: lender verifies documents and issues a conditional commitment (stronger signal to sellers).
Tip: request a written preapproval letter — it should include loan type, amount, and contingencies.
5. Shop lenders and compare loan estimates
– Ask at least 3 lenders (bank, credit union, mortgage broker).
– Compare Loan Estimates (a standardized 3‑page form you must receive within 3 business days after application). Focus on: interest rate, APR (annual percentage rate), origination fees, and estimated closing costs.
– Check lender reputation, responsiveness, and whether they service loans or sell them to investors.
6. Submit the formal application
– Complete the mortgage application (often the 1003 form).
– Pay any application/origination fees if required.
– Confirm your rate‑lock options and duration (e.g., 30, 45, 60 days). Locking protects against rate moves but may have a fee.
7. Processing, appraisal and underwriting
– Processing: lender orders credit reports, title search and appraisal. Provide any additional documents quickly.
– Appraisal: licensed appraiser estimates market value. If value 80% on conventional loans; it raises monthly cost until sufficient equity exists. Ask how and when PMI can be canceled.
– Conforming vs jumbo: conforming loans meet agency limits (Fannie/Freddie); jumbo loans exceed those limits and often require stricter credit and down payment.
– Rate vs APR: rate affects monthly payment; APR reflects estimated annual cost including certain fees — use APR to compare total cost across offers.
Practical checklist before signing
– Verify interest rate, loan term, and loan type (fixed vs adjustable).
– Compare Loan Estimate vs Closing Disclosure line‑by‑line.
– Confirm monthly payment and escrow setup.
– Ensure you understand prepayment penalties (rare for conventional) and PMI cancellation terms.
– Ask for the servicer contact and first payment instructions.
Timing expectations (typical)
– Preapproval: same day to a few days.
– Underwriting and closing: often 30–45 days from application, though complex files can take longer.
– Rate locks: choose a lock long enough to cover expected closing; note potential float‑down options.
Sources
– Consumer Financial Protection Bureau (CFPB) — How to get a mortgage: https://www.consumerfinance.gov/owning-a-home/getting-a-mortgage/
– Fannie Mae — Selling Guide overview and borrower resources: https://www.fanniemae.com/
– Freddie Mac — Mortgage basics and tools for borrowers: https://www.freddiemac.com/
– U.S. Department of Housing and Urban Development (HUD) — Buying a home: https://www.hud.gov/topics/buying_a_home
Quick borrower checklist (conventional mortgage)
– Get preapproved before house-hunting: supply pay stubs, tax returns, bank statements, ID. Preapproval is not a guarantee of final approval.
– Compare lenders on APR (includes fees) and not just headline rate. Ask for a Loan Estimate.
– Decide loan term and type (e.g., 30‑yr fixed vs. 15‑yr fixed
– Decide loan term and type (e.g., 30‑yr fixed vs. 15‑yr fixed
– Choose your down‑payment strategy and know PMI rules: conventional loans usually require private mortgage insurance (PMI) if you put down less than 20%. PMI is typically cancellable once your loan‑to‑value (LTV) ratio reaches 80% and must terminate automatically at 78% LTV under federal rules for most loans. Estimate monthly PMI as: annual PMI rate × current loan balance ÷ 12. Example: home price $300,000; 5% down → loan $285,000; PMI rate 0.50% → annual PMI = 0.005 × 285,000 = $1,425 → monthly ≈ $118.75. (Check lender‑specific PMI rates.)
– Compare points vs. rate reduction: one discount point = 1% of loan amount (paid upfront) and often lowers the interest rate by roughly 0.20–0.25% (varies). Do a breakeven calculation: compute monthly payment with and without the point and divide the point cost by the monthly savings to find months to recoup. Worked example: loan $300,000, 30‑yr. At 4.50% monthly payment ≈ $1,520; at 4.25% ≈ $1,476 → monthly savings ≈ $44. One point costs $3,000 → breakeven ≈ 3,000/44 ≈ 68 months (~5.7 years).
– Check qualifying ratios and documentation: lenders typically look at debt‑to‑income (DTI) and residual income. Gather pay stubs, W‑2s, tax returns, bank statements, and ID. Stay conservative with assumed income and avoid new debt during underwriting.
– Understand appraisal, title search, and insurance: the lender orders an appraisal to confirm value; a title search and title insurance protect against ownership defects. Homeowners insurance is required and must be in place before closing.
– Review Loan Estimate and Closing Disclosure: compare APRs (which include fees) across lenders, not just the note rate. You must receive a Closing Disclosure at least three business days before closing — use that time to confirm final costs and changes.
– Prepare for closing costs and reserves: typical closing costs run 2–6% of purchase price (lender fees, title, prepaid interest, escrows). Conventional loans may require reserves (several months of mortgage payments) for certain borrowers or higher risk profiles.
– Verify escrow and tax/insurance payments: decide whether taxes and insurance will be escrowed (collected monthly into an account) or paid directly. Escrow cushions can cause higher initial or monthly cash needs.
– Know seller contributions and concessions: seller-paid closing costs or credits are sometimes allowed but subject to lender and investor limits and may affect qualifying. Confirm allowed amounts with your lender.
– Understand timing and rate locks: lock a rate long enough to cover expected closing time. Ask about float‑down options or re‑lock costs. If your financial picture changes, inform the lender immediately — new credit pulls or job changes can trigger re‑underwriting.
– Maintain financial stability until closing: avoid opening/closing accounts, large deposits without documentation, new loans, co‑signing, or changing jobs. Such actions can delay or derail approval.
– Final walkthrough and closing
– Final walkthrough and closing (continued)
– Final walkthrough checklist: confirm agreed repairs are completed; utilities are on; no unexpected items left by seller; agreed fixtures/appliances are present. Take photos and note anything unresolved.
– Review the Closing Disclosure (CD) at least 24–48 hours before signing. Confirm loan terms, APR, monthly payment, itemized closing costs, seller credits, escrow amounts, and the exact amount of cash due at closing.
– What to bring to closing: government ID, cashier’s check or wire instructions for the exact funds the CD states, proof of homeowners insurance, and any additional documents the lender requested. Do not bring large undocumented cash deposits.
– Signing and funding: you’ll sign many documents (note, mortgage/deed of trust, disclosures, affidavits). After signatures, the settlement agent records the deed and the lender funds the loan. Only after recording does legal ownership and lender security interest become effective and keys are typically released.
After closing — what to expect and immediate actions
– First mortgage bill and payment setup: check when the first payment is due (often the first of the month after the first full month). Set up auto-pay if preferred to avoid missed payments.
– Escrow account mechanics: your lender may collect monthly amounts into escrow for property taxes and homeowners insurance. Twice-yearly or annual statements show account activity and any shortfalls or surpluses.
– Keep documents: store the note, deed, Closing Disclosure, and title insurance policy in a safe place. You may need them for tax, resale, or future refinancing.
– Monitor property taxes and insurance: increases can raise escrow payments and your monthly mortgage payment. Notify the lender promptly of any insurance changes or lapses.
Private Mortgage Insurance (PMI) on conventional loans
– What PMI is: private mortgage insurance protects the lender when a borrower’s down payment is below 20% of the home’s purchase price. It is not mortgage interest and is generally paid until sufficient equity is reached.
– When PMI is cancelled: under the Homeowners Protection Act, PMI must be automatically terminated when the balance reaches 78% of the original amortized value (i.e., loan-to-value, LTV, of 78%) if payments are current. Borrowers can request cancellation when they reach 80% LTV, provided they’re current on payments and meet lender requirements.
– How to get PMI removed early: accelerate principal payments or get an updated appraisal showing increased value. The lender will have a formal process; follow their documentation requirements (payment history, appraisal, no subordinate liens).
Worked numeric example (30-year conventional fixed)
– Scenario: purchase price $300,000, down payment 5% ($15,000), loan amount $285,000, 30-year fixed at 4.00% annual interest.
– Monthly interest rate r = 0.04/12 = 0.0033333333. Number of payments n = 360.
– Monthly principal & interest (P&I) payment formula: M = P * r / (1 − (1 + r)^−n).
– M = 285,000 * 0.0033333333