Who are Conventional Loans Best For?

This Article Is About Conventional Versus Government Loans For Home Buyers

The coronavirus pandemic has not slowed the housing market.

Even with the coronavirus outbreak in February 2020, the housing market roared with no signs of a housing market correction. Many experts predicted another housing market meltdown and correction. Boy, were they wrong. The Federal Housing Finance Agency and HUD both increased conforming and FHA loan limits for 2021 due to homebuyers being priced out of the market. The COVID-19 outbreak changed the way we work. Many companies have turned to remote positions for their employees.

Now with remote workers, they are not stuck in a particular geographic area. Remote wage earners can live anywhere they want. Many are fleeing high taxed states to lower-taxed states with affordable housing and cost of living. Mismanaged high-taxed states with incompetent governors like Illinois and New York are losing taxpayers like never before. Due to the ability to live anywhere for remote workers, many city dwellers renting an apartment are fleeing to the suburbs. and/or rural areas with affordable housing and becoming first-time homebuyers sooner than later.

Fannie Mae and Freddie Mac are loosening its credit guidelines so many more homebuyers are qualifying for conventional versus government loans.

Surge In Conventional Versus Government Loans

Conventional Versus Government Loans

Most mortgage companies are seeing a surge in conventional loans versus FHA loans due to many reasons. FHA loans are originated and funded by private lenders. HUD, the parent of FHA, is the government agency that insures FHA loans originated and funded by private lenders.
However, in order for HUD to partially insure lenders against default and losses by borrowers on FHA loans, lenders need to follow the minimum agency guidelines of HUD. Due to the government guarantee, lenders can offer a 3.5% down payment home purchase FHA loan with credit scores as low as 580 FICO at competitive mortgage rates.
FHA loans are for owner-occupant home financing only. Fannie Mae and Freddie Mac set the agency mortgage guidelines on Conventional loans. Conventional loans are often referred to as conforming loans because they need to conform to Fannie Mae and Freddie Mac Agency Guidelines.

Difference Between Conventional Versus Government Loans

Conventional loans are not backed by any government agency. Then why do conventional loans need to conform to Fannie Mae and/or Freddie Mac Agency Guidelines?
Mortgage bankers and correspondent lenders fund the loans they originate and fund by using their warehouse line of credit. A warehouse line of credit is like a giant revolving line of credit mortgage bankers use to fund the loans they close. Once they fund the loans they close, mortgage bankers and/or correspondent lenders need to sell the loans they funded on the secondary mortgage market. Ultimately, the end buyers of mortgages on the secondary mortgage market are Fannie Mae and/or Freddie Mac.
Smaller correspondent lenders may sell the loans to a larger mortgage banker. The larger mortgage banker can purchase a bunch of mortgages from groups of correspondent lenders and package them up and sell them to Fannie Mae and Freddie Mac. However, Fannie Mae and Freddie Mac will not purchase loans that do not conform to Fannie Mae and/or Freddie Mac Agency Guidelines.
Fannie Mae and Freddie Mac will only purchase conforming loans that meet their agency mortgage guidelines.

The Role Of Fannie Mae And Freddie Mac

Fannie Mae and Freddie Mac are the two mortgage giants that are the biggest buyers of mortgages in the secondary market.

The role of Fannie Mae and Freddie Mac is to provide liquidity in the mortgage markets by purchasing mortgages in the secondary mortgage markets. Due to Fannie Mae and Freddie Mac, lenders can sell the mortgages they fund and pay their warehouse lines of credit. By being able to pay their lines of credit, lenders can repeat making mortgage loans to consumers at competitive rates.
Conventional loans are becoming increasingly popular. More and more borrowers are opting to choose conventional versus FHA loans. There are mortgage guidelines that borrowers meet on conventional loans but not FHA loans.

  • For example, FHA loans do not accept Income-Based Repayment (IBR Payments on student loans.
  • However, Fannie Mae and Freddie Mac Agency Guidelines allow IBR Payments on student loans.

This also holds true on zero payment IBR payments.

HUD requires mortgage underwriters to use 1.0% of the outstanding student loan balance on the outstanding student loan balance if the monthly payment is not an amortized monthly payment on an extended payment plan.

Down Payment Requirements On Conventional Versus Government Loans 

Conventional loans allow a 3% down payment on a home purchase for first-time homebuyers.

A first-time homebuyer is a buyer who has not had an interest in homeownership in the past five years. Borrowers who had a prior mortgage included in bankruptcy can qualify for a conventional loan four years from the discharged date of bankruptcy. The finalization of the date of the housing event (foreclosure, deed in lieu of foreclosure, short-sale) does not matter. The mortgage cannot be reaffirmed. However, HUD will require a three-year waiting period from the finalization date of the housing event if there was a mortgage included in bankruptcy and the discharged date does not matter.
Fannie Mae and Freddie Mac have lightened their agency guidelines when it comes to prior bad credit. You do not have to pay outstanding collections and/or charged-off accounts on primary home conventional loans just like FHA loans. Mortgage guidelines on outstanding collections and charged-off accounts are different on investment properties.

Conventional loans are for owner occupant, second homes, and investment properties.

Skyrocketing Home Prices And The Mortgage Markets

Home prices are skyrocketing nationwide where many homebuyers are being priced out of the housing market. 2021 conventional loan limits are now capped at $548,250 versus the FHA loan limit is capped at $348,362. Both HUD and the FHFA have increased loan limits for the past five years due to skyrocketing home prices. With FHA loans, there is a one time upfront mortgage insurance premium of 1.75% and a lifetime of an annual FHA mortgage insurance premium of 0.85%.
The annual FHA MIP cannot be canceled and needs to be paid by the borrower for the lifetime of a 30-year fixed-rate FHA loan. Borrowers with at least a 680 credit score can qualify for a lender-paid mortgage insurance conventional loan (LPMI). What this means is the borrower just needs to pay a one-time upfront private mortgage insurance premium just like the Upfront FHA MIP and there is no annual mortgage insurance required for the life of a 30-year fixed-rate mortgage. If the value of the home falls below 80% LTV, private mortgage insurance can be canceled on conventional loans.

Peter has 7+ years of experience in residential lending. He is a licensed Realtor in the Chicagoland area.

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