Most borrowers seeking financing to purchase a home secure a conventional mortgage. The standards for these loans are set by Fannie Mae -- the Federal National Mortgage Association -- and Freddie Mac -- the Federal Home Loan Mortgage Corporation. Mortgage originators typically seek to sell conventional loans to Fannie or Freddie, so the originators must follow their standards. So-called conforming conventional mortgages have guidelines for the mortgage amount, credit score, downpayment and debt coverage ratios.
An approved appraiser gives an estimate of property value. Lenders use this information to determine how much they will allow an applicant to borrow. The loan cannot exceed 95 percent of this value if a primary mortgage insurance policy is included. Primary mortgage insurance reimburses the mortgage originator for part of the property value if the borrower defaults. Loans that do not include mortgage insurance cannot exceed 80 percent of the property value.
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Conventional loans require that the borrower has an average FICO score of 620 to 680. A FICO credit score is a measure of the borrower's creditworthiness based on past borrowing and repayment history. Lenders will access the borrower's credit history and credit score when evaluating a loan application. Borrowers with higher credit scores are offered better loan rates and may be allowed loan-to-value ratios on the higher end of the acceptable range.
Debt Coverage Ratios
The front-end ratio measures the proposed housing payment -- including mortgage, insurance, and taxes -- as a percent of the borrower's gross monthly income. This ratio cannot exceed 33 percent.
The back-end ratio measures all monthly payments on long-term debt as a percent of the borrower's gross monthly income. Long-term debt will include the proposed housing expense in the front-end ratio along with other sources of debt such as student loans, car loans, credit cards, alimony and child support. The back-end ratio should not exceed 45 percent.
The Federal Housing Finance Association sets the loan limit for a conventional mortgage. The loan limit has been $417,000 since 2006 for most areas of the United States. The limit does vary with housing cost, however, and is as high as $938,250 in places like Alaska and Hawaii.
Nonconforming Conventional Loans
Lenders who do not intend to sell a mortgage to Fannie Mae or Freddie Mac may be more lenient with their mortgage requirements, and they might offer nonconforming conventional loans. For example, they may approve a borrower whose credit score does not meet the standard for a conforming conventional loan. The application process is the same for all conventional loans.