• A conventional loan is a mortgage that is not guaranteed or insured by any government agency, including the Federal Housing Administration (FHA), the Farmers Home Administration (FmHA) and the Department of Veterans Affairs (VA). It is typically fixed in its terms and rate.

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  • Conventional Loans, Defined

    Mortgages can be defined as either government-backed or conventional. Government agencies like the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA) insure home loans, which are made by private lenders. This insurance is paid for by fees collected from mortgage borrowers. The US Department of Agriculture (USDA) loans money to lower-income borrowers through its Direct Housing Program. It also guarantees loans made by private lenders through its Guaranteed Housing Loans program. This backing is paid for by borrowers.

    Mortgages not guaranteed or insured by these agencies are known as conventional home loans. They include:

    • Conforming Loans
    • Non-conforming Loans
    • Jumbo Loans
    • Non-QM Loans
  • When a Conforming Loan Makes Sense

    If you have a credit score over 680 and a 5% down payment, you have the bare minimum required to explore working with a conventional conforming loan. Conforming loans also are stricter on employment history, requiring two years in the same field, as well as payment-to-income ratio, which is a max of 45%.

  • Conventional Loans Explained

    About half of all conventional loans are called “conforming” mortgages, because they conform to guidelines established by Fannie Mae and Freddie Mac. These two government-sponsored enterprises (GSEs) buy mortgages from lenders and sell them to investors. Their purpose is to make mortgages more widely available. All conforming mortgages are also conventional mortgages.

    Loans that do not conform to GSE guidelines are referred to as “non-conforming” home loans. Non-conforming loans that are larger than loan limits set by the GSEs are often referred to as “jumbo” mortgages. All non-conforming mortgages are also conventional mortgages. Conventional loans held by mortgage lenders on their own books are called “portfolio” loans.

    Because lenders can set their own guidelines for these loans and do not sell them to investors, these products may have features that other mortgages do not. For example, a portfolio lender might allow a borrower to use investments like stocks and bonds as security for a mortgage for which she would not otherwise qualify.

    Conventional home loans marketed to borrowers with low credit scores are called sub-prime mortgages. They typically come with high interest rates and fees. The government has created special rules covering the sale of such products, but they are not government-backed — they are conventional loans.

  • Qualifed Mortgage Rule

    Dodd-Frank Wall Street Reform and Consumer Protection Act outlined the features of a QM as follows:

    No Excessive Upfront Points and Fees – Points and Fees charged by a Lender to the Borrower must not exceed 3% of the total amount borrowed;

    No Toxic Loan Features – (a) No Interest-Only Loans, (b) No Negative Amortization Loans, (c) No terms beyond 30 years, and (d) No Balloon Loans;

    Limits on Debt-to-Income Ratios – General rule for Qualified Mortgage is 43%, a borrower’s DTI ratio must not be higher than 43%. There is a temporary exception granted for loans that are eligible to be sold or insured by Freddie Mac, Fannie Mae, FHA or VA. No other exceptions are allowed.

    Any other type of mortgage loan that doesn’t conform to the QM rule is considered a Non-Qualified Mortgage or Non-QM loans. A good example of Non-QM loan is an Interest-Only loan still being offered by some lenders. These types of loans are primarily provided to wealthy borrowers. The CFPB rule that requires lenders to document a borrower’s ability to repay a loan is excluded from being considered a QM because borrowers often face payment shock once they have an obligation to start paying the principal, often, after about 5 to 7 years of only paying interest on the loan.

    The compliance issue with the “Ability to Repay” rule is something that originating lenders have to follow strictly. There are eight underwriting factors to consider: The borrower’s current income and assets; The borrower’s current employment status; The borrower’s monthly payment on the covered transaction; The borrower’s monthly payment on any simultaneous loan; The borrower’s monthly payment for mortgage-related obligations; The borrower’s current debt obligations, alimony and child support payments; The borrower’s monthly debt-to-income ratio or residual income, and The borrower’s credit history.

    The compliance issue with the “Ability to Repay” rule is something that originating lenders have to follow strictly. There are eight underwriting factors to consider:

    • The borrower’s current income and assets;
    • The borrower’s current employment status;
    • The borrower’s monthly payment on the covered transaction;
    • The borrower’s monthly payment on any simultaneous loan;
    • The borrower’s monthly payment for mortgage-related obligations;
    • The borrower’s current debt obligations, alimony and child support payments;
    • The borrower’s monthly debt-to-income ratio or residual income,
    • The borrower’s credit history.