When people talk about mortgages, they’re usually referring to conventional loans.
The most common type of home loan, a conventional mortgage, can be used to purchase a primary residence, a vacation home, investment property, or another type of real estate.
What you may not realize is that there are different types of conventional loans — and knowing which is which can help you figure out the right one for your homebuying goals.
The term “conventional loan” refers to a broad category of mortgage options. Home loans that are not government-backed — which is to say, loans that are not VA, USDA, or FHA loans — are typically conventional loans.
But there are several types of conventional loans, including conforming, non-conforming, and jumbo. The right choice for your home purchase will depend on the price range you’re shopping in, your credit score, and other factors.
Conventional loans fall into two categories: conforming and non-conforming.
Conforming loans are the most common conventional loans. They’re so named because they “conform” to the lending guidelines set by Fannie Mae and Freddie Mac, the two government-sponsored enterprises (GSEs) in the U.S.
Now, we just said that conforming loans are not government-backed, then in the next breath said that conforming loans were regulated by “government-sponsored enterprises”. What’s going on?
Fannie Mae and Freddie Mac are owned by the government, but that wasn’t always the case. They were acquired, for lack of a better word, during the 2008 housing downturn. They are still under government control, but the loans they regulate are not “backed” by the government. Lenders are not compensated if the loans go into foreclosure as they are with FHA, VA, and USDA loans.
In this way conforming loans are both government-sponsored but not government-backed.
This lack of backing means that conforming loans must adhere to stricter guidelines: investors can’t count on a check from the government if the loan turns bad.
As such, the minimum credit score for a conforming loan is 620.
Debt-to-income ratio (DTI) is another standard from the GSEs. DTI represents your monthly debts compared to your monthly income, and mortgage lenders use that number to determine how much mortgage payment you can afford.
The DTI for conforming loans is usually 45%, though it can go higher in some cases.
Conforming loan limits are the maximum amount a mortgage company can lend a borrower in a given area. These limits change each year based on local housing prices, and they vary based on where you live.
|Property type||Contiguous States; Washington, D.C. & Puerto Rico||High-cost areas, Hawaii, Alaska, Guam & the U.S. Virgin Islands|
In 2021, the loan limit for single-family homes in most parts of the country is $548,250. But the limit increases in higher-cost areas. The limit in places such as Los Angeles, New York City, and other red-hot markets is $822,375.
Loan limits also depend on the number of legal units within the home you’re buying. The limit for a single-family home is lower than that for a triplex, for instance.
To find out the loan limit in your area, check the Federal Housing Finance Agency’s conforming loan limits map.
If you’re buying a home with a high purchase price, you may qualify for a high-balance conforming conventional loan. These loans exceed the national loan limit of $548,250 but still fall below the $822,375 high-cost area limit.
Homebuyers in areas such as Seattle or Denver may opt for high-balance conforming loans due to rising property values and prices in those markets.
High-balance conforming loans are different than jumbo loans, which we talk about below.
Related reading: 2021 Conventional Loan Limits: How Much Can You Borrow?
A non-conforming conventional loan is a mortgage that does not meet Fannie’s and Freddie’s guidelines. These include large loans that exceed the conforming and high-balance loan limits, as well as mortgages issued to borrowers with lower credit scores, higher DTIs, and other factors outside the conforming loan criteria.
A jumbo loan is a common type of non-conforming conventional loan. These are high-value mortgages with loan amounts above the local limits, and they often have higher credit score and down payment requirements.
For instance, a homebuyer might qualify for a conforming loan with a 640 credit score and a 3% down payment. But they might need a minimum 680 score and 10% down payment to get approved for a jumbo loan. But lenders can set their own criteria for jumbo loans, and some may have more flexible criteria. If you are denied a jumbo loan, call the next bank listed on Yelp, or a different bank in your town.
Generally speaking, jumbo loans have higher interest rates than conforming loans.
Conventional loans can have either fixed or adjustable interest rates.
With a fixed-rate mortgage, your interest rate — and payment — stays the same throughout the life of the loan. This can help with budgeting, and can provide peace of mind. Even if interest rates increase generally, you won’t have to worry about your payment going up.
Adjustable-rate mortgages, also known as ARMs, start with a low, fixed rate for an initial period — usually three, five, or seven years — after which the rate can increase or decrease depending on rate fluctuations in the market. That means your monthly payment amount can also go up or down.
ARMs introduce uncertainty to your housing budget long-term, but they can save you money in the first few years, as the initial rate is usually lower than what you’d find with fixed-rate loans.
Who should consider an ARM?
If you plan to move within a few years, or you’re in a job that requires you to relocate frequently, you might opt for an ARM to take advantage of the low interest rate and then sell before the variable period kicks in.
First-time homebuyers who are purchasing a starter home with the intention of buying a bigger place a few years down the road might also consider an ARM.
There are no guarantees that you’ll be able to sell, of course, and circumstances can change. If you end up staying in the home longer than expected, you might decide to refinance to a fixed-rate loan if rates are rising.
Keep in mind that you will pay closing costs on a refinance loan, so it’s important to math out the savings versus potential costs on an ARM before making a decision.
Your lender can give you a breakdown of how your payments may change and what your maximum payment might be, as there are caps on how high your mortgage rate can go.
Related reading: Conventional Loan Mortgage Rates: Are They Rising in 2021?
If you want to buy a property that needs renovations before you move in, a conventional renovation loan could be a good option for you. Conventional renovation loans allow you to buy a property and finance the renovation costs with a single mortgage loan.
Both Fannie Mae and Freddie Mac offer these types of loans. They’re called HomeStyle and CHOICERenovation loans, respectively.
An alternative to the conventional rehab loan is the FHA 203k mortgage. This is a government-backed loan that also lets you purchase and rehab a property with one single mortgage. FHA loans can be easier to qualify for than conventional loans, as they have a lower credit score minimum (580) and more flexible DTI limits (can be 50% or higher in some cases).
Other types of conventional loans
We’ve covered several types of conventional loans already, but there are others as well. You can use conventional loans to build a house from the ground up, buy a rental property, or refinance your existing mortgage.
Keep in mind that not all these options are available from Fannie Mae or Freddie Mac. Many of the programs will vary by lender and may not be available from most companies.
You can use a conventional construction-to-permanent loan to build your dream home from the ground up. These mortgages can help you pay for the materials, labor, and other costs of constructing your house. A conventional construction loan can be used to finance the home construction and the purchase of a plot of land, or you can get a separate loan to buy the land.
There are several types of conventional construction loans, including the construction-to-permanent option mentioned above.
If you own the land already, you can take out a construction-only loan to pay for the work and materials to have the house built. Once it’s complete, you can either pay off the loan or refinance it to a regular mortgage on the home.
Or, if you’re a general contractor and want to oversee the construction yourself, you may qualify for an owner-builder loan.
Conventional loans can also be used to purchase investment properties, including rental homes, duplexes, triplexes, and more. You can also use them on second homes or vacation houses you intend to list on Airbnb to earn extra income.
Investment properties are riskier for lenders, so they usually require a higher down payment and credit score. You’ll also likely pay a higher interest rate.
Here’s a way to get around this, though: Use a conforming loan to buy a multifamily property. As long as one of the units will be your primary residence, you can rent out the other three. Meanwhile, you can qualify for a lower interest rate and put down less than you’d need for an investment loan.
If you’re looking to reduce your mortgage payments or otherwise refinance your home loan, there are a number of conventional loan refinance options.
These include but are not limited to:
- Rate and term, which let you change your loan’s interest rate or loan term
- Cash-out, which allow you to borrow cash against your home equity to pay for home renovations or other expenses
- High loan-to-value (LTV)/enhanced relief, which are options if you have a very high loan-to-value ratio (meaning you owe a lot on the home compared to its market value)
The best refinance option depends on your goals, budget, and the terms of your existing mortgage. If you’re not sure which one’s right for you, a mortgage lender can advise you on the best options for your financial situation.
FHA and USDA loans, which are backed by the federal government, include upfront and ongoing mortgage insurance. That’s the trade-off for having more lenient borrower criteria and low interest rates that make homeownership accessible to more borrowers.
Conventional loans also have a private mortgage insurance (PMI) requirement, but only on loans with less than 20% down. And when homeowners reach 20% equity, they can request that PMI be removed.
FHA and USDA borrowers can avoid paying mortgage insurance for the life of their loans by refinancing to a conventional loan once they have 20% home equity.
Types of conventional loans FAQs
The two types of conventional mortgages are conforming and non-conforming loans. Conforming loans “conform” to guidelines set by the government-sponsored enterprises Fannie Mae and Freddie Mac, including borrower criteria and loan limits.
Non-conforming loans fall outside Fannie’s and Freddie’s parameters, and they include jumbo loans that exceed the conforming loan limits.
Conforming conventional loans for a primary residence require at least 3% down. Other conventional loan programs may require higher down payments, particularly if they are high-value jumbo loans or investment loans.
To qualify for a conventional conforming loan, you’ll likely need a 3% down payment, 620 or higher credit score, and a maximum debt-to-income ratio of 45% (though lenders may be able to accept a higher DTI in some cases).
But guidelines vary based on the type of loan you need, and private lenders can set their own criteria as well. If you want to buy an investment property or a luxury home, you may need to put more money down and have a higher credit score.
There are many types of conventional loans, and the right one really depends on your goals, the price of the homes you’re considering, and other factors.
A lender can help you choose the right mortgage and build your homebuying strategy.