Conventional Loan Guidelines: The 3% Down Reality

Conventional mortgages are backed by Fannie Mae and Freddie Mac. Unlike government-backed loans (FHA/VA), Conventional loans aren't explicitly insured by the government, meaning they rely heavily on Private Mortgage Insurance (PMI) to offset the risk of low down payments.

Who can use 3 percent down?

Fannie Mae and Freddie Mac offer several ways to buy a home with only 3% out of pocket. You don't need 20% down.

• Standard 97% LTV: Available to any borrower where at least one person on the loan is a first-time homebuyer (defined as not owning a principal residence in the last 3 years).
• Fannie Mae HomeReady®: A specialized 3% down program for low-to-moderate-income borrowers. Even if you are not a first-time homebuyer, you can use this program if your income is at or below 80% of the Area Median Income (AMI). It offers significantly reduced mortgage insurance (PMI) rates.
• Freddie Mac Home Possible®: Very similar to HomeReady, this 3% down program also caps income at 80% AMI but offers massive flexibility for multi-generational households and manual underwriting.

What if I have owned before?

If you make too much money for HomeReady and you aren't a first-time homebuyer, the standard minimum down payment for a Conventional primary residence is simply 5%. You can still keep 95% of your cash in the bank.

The 20% Sweet Spot: Why do people talk about 20% down? Because if you put down 20% on a Conventional loan, you completely avoid paying Private Mortgage Insurance (PMI). You save hundreds of dollars a month, but you tie up a massive amount of liquidity in the drywall of the house.

While an FHA loan offers roughly the same interest rate to a borrower with a 640 score as a borrower with a 740 score, Conventional loans are entirely different. They use Loan-Level Price Adjustments (LLPAs).

What score do I actually need?

The technical minimum credit score allowed by Fannie Mae and Freddie Mac is 620. However, if you apply for a Conventional loan with a 620 credit score and only 3% down, the LLPAs (risk penalties) applied to your interest rate and your monthly PMI cost will be astronomically high. In those cases, an FHA loan usually costs less.

What changes above 740?

Conventional loans heavily reward excellent credit. Borrowers with scores of 740 or higher see significantly lower interest rates and drastically cheaper Private Mortgage Insurance premiums. If you have great credit, a Conventional loan will beat an FHA loan over time because the PMI is cheaper and eventually drops off.

Conventional loans are historically stricter on Debt-to-Income (DTI) ratios than government loans. DTI is the percentage of your gross monthly income that goes toward paying your total monthly debts (including your new mortgage). To see what that means in real dollars, look at how much income you need for a $400K mortgage in Florida.

What if my ratio is over 45 percent?

AAA Capital Funding doesn't add its own overlays on top of the agency rules.

If Fannie Mae's Desktop Underwriter (DU) or Freddie Mac's Loan Product Advisor (LPA) returns an "Approve/Eligible" finding, a Conventional loan can go up to a 50% back-end DTI. To get there, the underwriting system looks for strengths elsewhere in the file, like a higher credit score, solid cash reserves after closing, or a larger down payment.