6 Types of Conventional Loans to Choose From
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If you’re not interested in taking out a government-backed mortgage for your home purchase, then you’re likely leaning toward a conventional mortgage. Before you move forward, though, be sure you understand the different types of conventional loans that exist.
In this article:
- What is a conventional loan?
- 6 types of conventional loans
What is a conventional loan?
A conventional loan is a mortgage that isn’t backed by the federal government, such as the loans insured by the Federal Housing Administration (FHA) or the U.S. Department of Veterans Affairs (VA).
While private lenders provide both conventional and government-backed loans to borrowers, the minimum requirements for conventional loans are stricter than those for government loans. For example, you can get an FHA loan with a credit score as low as 500, while you’ll need at least a 620 credit score to qualify for a conventional loan.
Additionally, though conventional mortgages have a higher barrier of entry, they usually cost less than government-backed mortgages.
6 types of conventional loans
There are several types of conventional loans, including conforming and non-conforming loans. Here are six different forms of conventional financing.
What are they? Conforming loans are the most common loan type, according to the Consumer Financial Protection Bureau (CFPB). They conform to lending guidelines set forth by Fannie Mae and Freddie Mac, the two major agencies that buy and sell mortgages from private lenders.
Fannie and Freddie must purchase loans that fall within the loan limits set by the Federal Housing Finance Agency, which is why conventional loan limits exist. The 2020 maximum limit for conforming loans on single-family homes is $510,400 for most counties across the U.S.
Who are they best for? Mortgage borrowers with good credit and low debt-to-income ratios who are looking to get a mortgage with a loan amount that doesn’t exceed conforming loan limits.
Non-conforming or ‘jumbo’ loans
What are they? Jumbo loans, also known as non-conforming loans, are conventional mortgages that exceed the conforming loan limits in a given area. Luxury homes are often associated with this loan type.
Because their significantly higher balances don’t conform to Fannie Mae and Freddie Mac guidelines, jumbo loans aren’t eligible for purchase by either entity.
Jumbo loans differ from high-balance loans, which are conforming loans with higher balances to reflect average home prices in high-cost areas, such as several counties throughout California and New York. The conforming loan limit for single-family homes in high-cost areas in 2020 is $765,600.
Who are they best for? Borrowers looking to finance the purchase of a home that costs more than the conforming loan limit in their desired county.
What are they? A non-qualified mortgage is a loan that caters to homebuyers with low credit scores or other unique financial situations, such as self-employed borrowers or those who rely on commissions or bonuses for a bulk of their income. They typically have higher mortgage rates and fees than prime mortgages, which are reserved for buyers with excellent credit scores. However, non-qualified mortgage lenders still have to ensure borrowers have the ability to repay their loans, as required by new legislation enacted after the housing crisis.
Who are they best for? Homebuyers who have serious blemishes on their credit profile, a DTI ratio above 43% or other unique financial situations, but can comfortably afford a mortgage.
What are they? Portfolio loans are mortgages that lenders hold on their own books, rather than sell them to Fannie Mae, Freddie Mac or other investors. Lenders can establish their own guidelines for portfolio loans, which means they may have unique characteristics, such as giving borrowers the ability to use investment funds for a down payment without actually withdrawing money from their accounts.
Who are they best for? Mortgage borrowers looking for a lender with flexible loan eligibility guidelines.
What are they? A fixed-rate loan is a type of conventional mortgage that has the same interest rate for the life of your loan and won’t change. The principal and interest portion of your monthly mortgage payment will be the same amount each month. Generally, the longer term you choose for a fixed-rate loan, the higher your interest rate will be.
Who are they best for? Borrowers who want predictable, stable mortgage payments.
Adjustable-rate mortgages (ARMs)
What are they? An adjustable-rate mortgage has an interest rate that changes rather than stays the same. Many ARMs begin with a fixed-rate period, however, that can last for the first several years of the loan. For example, if you have a 5/1 ARM, your mortgage rate would be fixed for the first five years and then adjust annually for the remainder of the loan term.
ARMs typically start out with lower rates than fixed-rate mortgages, but you can expect rates to increase over time. Most ARMs have a lifetime cap of 5%, which means during the years that the rate adjusts, it can go as high as 5% above the initial fixed rate, according to the CFPB.
Who are they best for? Homebuyers planning to refinance their mortgage or sell their home before the interest rate begins adjusting.