The real estate market holds many promises for investors. Investing in a property is one of the best ways to save up for retirement, earn some passive income, and also create a diversified investment portfolio. However, buying a home or property is very expensive at the moment, and investors have to seek financing to afford the investment they are eyeing. This is where real estate loans come in. There are different types of real estate loans that we at Money Lender Loans offer to investors in Orange County, among them are conventional mortgages.
Understanding Conventional Mortgages
Conventional loans/mortgages are types of home loans that are not insured or guaranteed by the Federal Government. Ordinary home buyer’s loans are usually secured by government entities like the United States’ Veterans Affairs Department, Federal Housing Administration popularly known as FHA, and the USDA Service for Rural Housing. Conventional loans are, instead, offered through two enterprises that are government-sponsored, namely the Federal Home-Loan Mortgage Corporation, also known as Freddie Mac and the Federal National Mortgage Association, known as Fannie Mae.
Some people mistake conventional loans for conforming loans. Even if they are closely related, the two types of loans are significantly different. Conforming mortgages are the types of loans whose conditions and terms of issuance are designed to meet the loaning principles of Freddie Mac and Fannie Mae. Top among those conditions is a loan limit, which is annually set by the Federal Government’s Housing Finance Agency. In 2019, for instance, the limit for all loans in most parts of the United States was $484,350.
This makes all types of conforming loans conventional, and it means that not every conventional credit can qualify to be conforming loans. A considerable mortgage loan amounting to $900,000, for instance, will not be eligible as a conforming loan since it goes beyond the set limit, but it is a conventional loan.
Conventional loans are quite popular in the United States, constituting more than two-thirds of all home mortgages dispensed in the country today. There is a high demand for these kinds of loans, which require a down-payment of 3% on the minimum. The loan allows borrowers who pay a higher down payment of about 20% not to pay any mortgage insurance for their loans, which sets them apart from FHA loans.
There are mainly two types of conventional mortgages:
- Secured loans- a borrower will need to have some form of collateral to qualify for this kind of loan. With a good guarantee, they will be able to get a loan at a much lower interest rate
- The signature or unsecured loans- this type of loan is based on the borrower's financial situation and their creditworthiness. These types of loans are a little bit expensive
How Conventional Mortgages Work
At the beginning of 2007, many home loans were defaulted, which contributed a lot to the severe recession that was felt many years later. After that, home loan lenders became a little strict on the way they were issuing out home loans. Today, there are no loans without verification or down payments, as a way to discourage defaulters from applying for mortgages they may not be able to pay back. Even though the majority of the elementary requirements that were there before are still there today, there is a lot more that has been added to the requirements to ensure that only fully qualified borrowers are getting home loans.
Potential mortgage borrowers today have to fill in an official loan application form and pay a loan application fee, and then provide the loan lender with all the required documents they can use to conduct an extensive background investigation on their credit history as well as their current credit rating before approving the application.
Before approving or rejecting the investor's application, a mortgage lender will check into his/her assets and obligations to see if the applicant will be able to make the monthly mortgage payment as per their agreement. The monthly payment is always set to at least 28% of the borrower's gross income. Some loan lenders will require the investor to make an upfront fee on the home they are eyeing, and therefore will be interested in finding out if he/she will indeed handle the deposit and if yes, how much money he/she can part with.
There are other costs that the loan lender will consider too, for instance, the upfront costs like underwriting/origination fees, settlement, and closing costs, as well as broker fees. All these will increase the overall value of the loan.
The Requirement to Apply for a Conventional Mortgage
Loan lenders differ in the kinds of requirements they would want from a mortgage borrower. Here are the most common requirements for one to obtain a conventional mortgage:
Proof of the applicant’s income
The loan applicant will be required to submit documents that will prove their income. Such documents are for instance pay stubs, which show the applicant's wages for an entire month, a document showing government tax returns for at least two years, statement of accounts for at least two months or quarterly (including savings, checking and investment accounts), and W-2 statements for at least two years.
In case of additional income such as bonuses or alimony, loan borrowers must be well prepared with documents to show proof of the same.
Documents for all assets owned by the applicant
The loan lender will be interested to know about all the assets you own; therefore, it will require current bank reports and statements for your investment accounts. This will act as proof that you will indeed be able to pay the down payment for the mortgage loan as well as closing charges on the property you are buying. If you have any cash reserves, proof of the same will be needed. If you are planning to borrow money from family or friends to make the deposit payment, your lender will need to see the gift letter, certifying that the money you are receiving is not a loan and that you have no obligation on paying it back. These letters will have to be authenticated.
A stable source of income shows that the loan borrower will be able to make monthly repayments as per their agreement with the mortgage lender. That is why proof of employment is required. Most loan lenders these days want to loan money to people who have a stable history of income. A one-month pay stub is not enough to show a lender that the borrower has a steady job. There is a need to prove that he/she is still under employment and that they are still receiving an income, and how much income that is. If you have changed jobs recently, a mortgage lender might want to get in touch with your previous manager. Self-employed mortgagors may need to submit additional paperwork to prove a regular business income.
Other documents that may be needed will include the loan applicant's driver's license, their Social Security number, state ID, and signature. These will enable the loan lender to obtain a report on your credit to know how creditworthy you are.
Interest Rates for Conventional Loans
When it comes to conventional loans, interest rates are usually higher when compared to mortgage loans that are sponsored by the government, for example, FHA loans. There are several factors that loan lenders use to determine the interest rates they charge on their loans. These are, for instance:
- The length of the repayment period
- The size of the loan
- Whether or not the loan has an adjustable or permanent interest rate
- Financial market and economic conditions
Like other mortgage lenders, conventional loan lenders set their interest rates depending on how their expectations for future inflation are as well as the demand and supply of securities that are mortgage-backed. If, for instance, the Federal Reserve increases its borrowing costs for banks, the banks will turn the increase over to their clients. That is why loan rates go higher, including mortgage rates.
Linked to conventional loan rates are points, which means the charges that are paid to a broker or a loan lender. The additional points a loan borrower pays, the lower the interest rates they will pay on loan. One point is valued at 1% of the total amount of loan, and it reduces a borrower's interest rate by around .25%. For an investor who is buying a home, they intend to live in for more than ten years; they should consider using the points to maintain low-interest rates for the entire period of the mortgage.
Lastly, the last determining factor is the financial profile of the loan borrower. A person's financial profile is determined by their creditworthiness, assets owned, and the amount of down payment the borrower can pay on a property they are buying. If your financial profile is good, the loan lender will give you the loan at a fair rate.
The Advantages and Disadvantages of Conventional Loans
Several benefits and setbacks come with conventional loans. These are, for instance:
- A higher down payment required for a borrower to obtain the loan enables the equity to build faster. With a higher down payment, the portion of the property that you own is usually more significant.
- The loan lender does not require borrowers to have private mortgage insurance, which reduces the overall cost of the loan in the end.
- Unlike with most government-supported mortgage loans, loan lenders offering conventional loans are willing to negotiate with borrowers for better terms and conditions of their loans. The loans do not have a standard guideline in which the borrower must follow.
- A conventional loan is processed much faster when compared to government-sponsored loans.
- The requirement to pay a higher down payment for the property makes it hard for most home buyers to afford the conventional loans in the first place. If the borrower is unable to make a sizeable down payment, they are required to have private mortgage insurance, which will cost them more in the end.
- Conventional loans will be more expensive for borrowers with a low credit rating since they are charged a higher interest rate.
- Some loan lenders may require an applicant to pay a non-refundable loan application fee
- If approved, borrowers may face stiff penalties if they fail to meet the end of their bargain in repaying the conventional loan
Who is Considered for a Conventional Loan?
Not every mortgage applicant is eligible for conventional loans. These types of loans are only meant to benefit a few loan applicants, such as those whose credit reports are good and well established, and those who have a strong financial standing. In determining the loan applicants who get to receive the loan, conventional loan lenders consider the following:
- Whether the loan applicant has a credit rating of at least Most lenders prefer lending borrowers with a credit score of over 700. Those who have a higher credit rating will be given the loan at a lower interest rate. The best lending terms are preserved for borrowers whose credit rating is 740 and above.
- Whether the borrower's debt-to-income ratio is acceptable - The debt-to-income ratio is the total of all the obligations you have on your monthly income. The adequate ration should be between 36% and 43%, and not beyond that.
- Whether the borrower can pay a minimum of 20% of the investment cost. Some lenders will accept less than that, but they will require the borrower to obtain private insurance for the mortgage and also pay the premiums every month until they attain the 20% mark of the property's equity.
These are some of the reasons why conventional loans are best suitable for investors who want to buy a home as their second resident or want to invest in a property worth more than $500,000.
Who Cannot Qualify for Conventional Loans?
As mentioned above, not everyone who wants to invest in real estate property can obtain a conventional mortgage. Investors who are only getting started in life will, for instance, not be considered for this kind of financing. Similarly, people who have more debts than normal, as well as those whose credit rating is modest or low will have problems getting their conventional loan applications approved. Generally, applicants who may not get the loan are:
- Those that have suffered foreclosure or bankruptcy within seven years
- Those whose credit rating is below 650
- Those whose debt-to-income ratio is over 43%
- Those who are unable to make at least 20% or, at the least, 10% of that property’s down payment.
How to Apply for a Conventional Mortgage
The process of buying a new home starts with the home buyer deciding on the type of mortgage loan they will go for. Fortunately, there are different types of mortgage loans to decide on, including FHA and conventional mortgages, which are the most popular types. If you have agreed to work with a conventional mortgage, it is time to go through the application process to ensure that you have the money on time to acquire the property you are eyeing.
Since conventional loans are usually not sponsored by the government, they may have a more strict underwriting and approval process when compared to government-sponsored loans. However, if you have all the requirements in place, and you fully qualify for the loan, you can proceed with the application process. Most conventional loan lenders have standard application criteria that borrowers must go through.
Obtain the preapproval letter
Since you already know the type of home you want to buy and the amount of mortgage loan you need, you should reach out to the loan lender for a preapproval. To get this letter, the loan lender will want to know your income, the amount you have in debts, and whether you own your current home or you are renting. This way, he/she will be able to assess how much money you will qualify to get a mortgage.
Make a formal application for the loan
There is a standard loan application form that is used by most conventional mortgage lenders, which is called the uniform residential loan application. The form contains detailed questions about the type of mortgage the borrower wants, the kind of property they are buying, and their finances. Some sections will probe your employment history, assets, and liabilities you own, and the amount of income you get. All the parts of the application form should be filled, after which the loan lender will schedule for an appraisal.
The underwriting and closing processes
Underwriting is done once every detail in the application form has been verified, and the appraisal and title work has been completed. Underwriting entails determining whether the loan application will be accepted or denied. If the loan is approved, it will be considered clear to close. If not, you will get a detailed explanation of why your loan application was denied.
Find a Mortgage Loan Near Me
Buying a home is an exciting thing, but the process can be a little overwhelming, especially for a first-time buyer or investor. The process can be a little taxing if you want to obtain a conventional loan. What you need is help and support throughout the process, which is precisely what Money Lender Loans offers to new home buyers. Call us at 949-409-4372 if you are in Orange County, and let us make the process smoother for you.