The Ultimate Guide to Traditional Mortgages
In Financing Your Home Purchase, by Anthony Bayardelle
Whether people refer to it as a traditional mortgage, a conventional home loan, or a fixed-rate mortgage, they are all talking about the same thing.
A traditional mortgage is a home loan that is not insured or backed by any specific government agency, but rather is provided through a bank. According to the National Association of Home Builders, conventional mortgage has accounted for 73.8% of all the new home loans procured in 2018. Bankrate confirms that this number has been over 71% for the past seven financial quarters, making this by far the most popular loan choice for home buyers.
What is a Traditional Mortgage?
Basically, a traditional mortgage is fixed-rate, 30-year loan that is not guaranteed by any government agency.
Just to cover the basic terminology, a fixed-rate loan is one which has the same interest rate throughout the course of the entire loan. (This is in contrast to an adjustable-rate loan, where your interest rate can change throughout the course of the loan.)
Overall, the interest rates of your loan depends on who your lender is, what is going on with the mortgage industry and with Fannie Mae, and others factors specific to your deal.
What is a Fannie Mae and Why is It Important?
This is one of those terms that almost everyone has heard, but very few actually understand.
Fannie Mae is a nickname created to represent the acronym of the Federal National Mortgage Association. This is a government-sponsored organization which finances mortgage lenders and homeownership across the country.
Fannie Mae is important to the average homebuyer, even though they are technically a provider of government-sponsored mortgages, because many big banks follow the guidelines they create.
Is it Hard to Get a Traditional Mortgage?
Relatively speaking, it is harder to get a traditional mortgage than is to get a government-sponsored home loan, but that doesn’t mean it’s necessarily “hard”.
For buyers with a good or excellent credit score, it shouldn't be that challenging to secure a traditional mortgage with a decent rate. Usually this means you have to have an average credit score in the mid-to-high 600s to secure a traditional mortgage. (For a complete guide of what mortgages you can get with what credit scores, check out my blog on what credit score you need to buy a house.)
The other thing that makes it “harder” to get a traditional mortgage then some other forms of loan is that they generally prefer you to have 20% of your sale price upfront as a down payment. Of course, this is not a firm figure and there are many factors that influence the necessary amount for a downpayment, but 20% is the general rule of thumb for a traditional mortgage. (For more information on down payments, PMI, and different mortgage types, check out my Ultimate Guide to Down Payments.)
What are the Advantages of a Traditional Mortgage?
The main advantage of a traditional mortgage is that it is generally easier, faster, and less of a hassle to get then some of the government-sponsored mortgage choices (like FHA or VA loans).
The other primary advantage to a traditional mortgage is that the interest rate is generally lower than that of a government-sponsored mortgage. Interest rates vary frequently, but you can always check out the latest mortgage rates for a variety of different lenders online.
Overall, if you qualify for a conventional mortgage and can make a 20% down payment, a traditional loan often does save you money in the long run.
What are the Disadvantages of a Traditional Mortgage?
While there are many advantages of a traditional mortgage, which is what makes them so popular overall, there are also some key disadvantages that come with it.
Mostly, a traditional mortgage is hard to get for buyers with low credit. If your credit falls below 620, it is still sometimes possible to get a traditional mortgage, but it is less likely and you'll probably get a higher interest rate than your a similar buyer with a higher credit score.
Similarly, the fact that a traditional home loan usually requires a 20% down payment (at least to avoid paying PMI) deters some buyers.
Finally, smaller disadvantages is going with a traditional mortgage. For example, with an FHA loan you can often roll your closing costs and fees into your mortgage, but this is not possible with a traditional home loan.
What is the Minimum Downpayment for a Conventional Mortgage?
The absolute minimum down payment for a conventional mortgage is 5%.
However, if you put anything less than 20% down you will probably be required to pay PMI (or Primary Mortgage Insurance). PMI is basically an extra layer of protection for whatever bank or entity is providing your home loan. If you provide less than a 20% down payment you are a greater risk of not paying off your loan, so they attach this extra insurance (usually between 0.5% and 1% of your total loan) to your monthly payment as a safety measure.
Check out my blog on down payments for the full information on PMI and how to avoid or get rid of it.
What is a Good Mortgage Rate for a Traditional Mortgage?
According to Credit.com, as of 2018 average mortgage rates true Banks was 3.59% and the average rate for a 30-year traditional mortgage through a credit union was 3.67%. However, these rates have gone up to an average of 4.60% in 2019 (ValuePenguin).
Of course, these rates fluctuate throughout any given day, not to mention over a longer period of time, so it's important to consider many different factors when considering different mortgage rates. As I mentioned above, interest rates may vary often, but you can check out the latest mortgage rates across multiple lenders online.
Your interest rate can also depends on factors specific to your sale, like what state you’re in, whether you get a credit for the closing costs, or other specific points of negotiation between you and your lender.
If you want to get a good mortgage rate, there are several important things you need to focus on. First, improving your credit score is probably the quickest way to improve your chance at a good interest rate. You can also demonstrate continuous employment and stability of income to make lenders far more comfortable with your application. (According to Forbes, typically banks prefer maximum back-end debt-to-income ratio of 36% for a traditional mortgage.)
Finally, as with most things, you want to shop around and do your research before choosing a home loan. This is the best way across the board to get a good mortgage rate.
Summary: What are the Requirements for a Conventional Loan?
Downpayment: 5%-20%, but usually 20%
Credit Score: Above 620
PMI: Yes, if your down payment is under 20%
Preferred Debt-to-Income Ratio: Dependent on your lender, but typically under 30%
Traditional mortgages are the most popular home loan by far, and carry significant benefits. If you want to know if you qualify for a traditional mortgage, schedule a free consultation call to go over your specific situation.