7 Types of Conventional Loans to Choose From
If you’re looking for the most cost-effective home loan available, you’re likely in the market for a conventional loan. Before committing to a lender, though, it’s crucial to understand the types of conventional loans available to you. Every loan option will have different requirements, benefits and drawbacks.
What is a conventional loan?
Conventional loans are simply mortgages that aren’t backed by government entities like the Federal Housing Administration (FHA) or U.S. Department of Veterans Affairs (VA). Homebuyers who can qualify for conventional loans should strongly consider this type of loan, as it’s likely to provide less costly borrowing options.
Things You Should Know: Conventional Loan Requirements
Conventional lenders often set more stringent minimum requirements than government-backed loans. For example, a borrower with a credit score under 620 won’t be eligible for a conventional loan, but would qualify for an FHA loan. It’s important to look at the full picture — your credit score, debt-to-income (DTI) ratio, down payment amount and whether your borrowing needs exceed loan limits — when choosing which mortgage loan will be the best fit for you.
7 types of conventional loans
What are they? Conforming loans are the subset of conventional loans that adhere to a list of guidelines issued by Fannie Mae and Freddie Mac, two unique mortgage entities created by the government to help the mortgage market run more smoothly and effectively. The guidelines that conforming loans must adhere to include a maximum loan limit, which is $726,200 in 2023 for a single-family home in most U.S. counties.
Who are they best for? Borrowers who meet the minimum credit score, DTI and other requirements for conforming loans and don’t need a loan larger than current conforming loan limits.
Nonconforming or ‘portfolio’ loans
What are they? Portfolio loans are mortgages that are held by the lender, rather than being sold on the secondary market to another mortgage entity. Because a portfolio loan isn’t going to be passed on, it doesn’t have to conform to all of the strict rules and guidelines associated with Fannie Mae and Freddie Mac. This means that portfolio mortgage lenders have the flexibility to set terms that can make qualification easier for borrowers.
Who are they best for? Borrowers looking for flexibility in their mortgage in the form of lower down payments, waived private mortgage insurance (PMI) requirements or loan amounts that are higher than conforming loan limits.
What are they? Jumbo loans are one type of nonconforming loans that don’t stick to the guidelines issued by Fannie Mae and Freddie Mac in a very specific way: by exceeding maximum loan limits. This makes them riskier to jumbo loan lenders, meaning borrowers often face an exceptionally high bar to qualification — interestingly, though, it doesn’t always mean higher rates.
Be careful not to confuse jumbo loans with high-balance loans. If you need a loan larger than $726,200 and live in an area that the Federal Housing Finance Agency (FHFA) has deemed a high-cost county, you may be able to qualify for a high-balance loan, which is still considered a conventional, conforming loan.
Who are they best for? Borrowers who need access to a loan larger than the conforming limit amount for their county.
High-balance loans are more expensive
Conventional loan borrowers will pay a higher interest rate or an extra fee at closing if they choose a high-balance loan. The fee is between 0.5% and 2.75% of the loan amount depending on the loan-to-value (LTV) ratio and whether the loan is a fixed- or adjustable-rate mortgage (ARM).
What are they? A fixed-rate loan has a stable interest rate that will stay the same for the entire life of the loan. This creates clear expectations for the borrower, eliminates surprises and provides a payment plan in which monthly principal and interest payments never vary.
Who are they best for? Borrowers who want stability and predictability in their mortgage payments.
Adjustable-rate mortgages (ARMs)
What are they? In contrast to fixed-rate mortgages, adjustable-rate mortgages have an interest rate that will change over the loan term. Although ARMs typically begin with a low interest rate (compared to a typical fixed-rate mortgage) for an introductory period, borrowers should expect a rate increase after this period ends. Precisely how and when it’ll increase is determined by the specifics of the loan: A 5/6 loan, for instance, will hold a steady rate for five years before beginning to adjust every six months.
Who are they best for? Borrowers who are able to refinance or sell their house before the end of the fixed-rate introductory period may save money with an ARM.
Adjustable-rate loans can come with extra fees
Beginning May 1, 2023, conventional ARM loans with LTVs higher than 90% will come with either higher interest rates or an extra fee of 0.250% at closing.
Low-down-payment and zero-down conventional loans
What are they? Homebuyers looking for a low-down-payment conventional loan or a 100% financing mortgage — also known as a “zero-down” loan, as no cash down payment is necessary — have several options.
Buyers with strong credit may be eligible for a number of loan programs that require only a 3% down payment. These include the conventional 97% loan, Fannie Mae’s HomeReady® loan and Freddie Mac’s Home Possible® and HomeOne loans. Each program has slightly different income limits and requirements, however.
Who are they best for? Borrowers who don’t want to put down a large amount of cash, need to boost their down payment to avoid PMI or want to split their loan amount in order to avoid a “jumbo” loan.
What are they? Just as nonconforming loans are defined by the fact that they don’t follow Fannie Mae and Freddie Mac’s rules, nonqualified mortgages are defined by the fact that they don’t follow a set of rules issued by the Consumer Financial Protection Bureau (CFPB).
Nonqualified mortgages are given to borrowers who can’t meet the requirements for a traditional loan. While they often serve borrowers with bad credit, they can also provide a way into homeownership for a variety of people in nontraditional circumstances. The self-employed or those who want to purchase properties with unusual features, for example, can be well-served by a nonqualified mortgage, as long as they understand that these loans can have high mortgage rates and other uncommon features.
Who are they best for? Homebuyers who have a low credit score, high DTI ratio or find themselves in unique circumstances that make it difficult to qualify for a traditional mortgage, yet are confident they can safely take on a mortgage.
Pros and cons of conventional loans
Lower down payment than an FHA loan. You can put down only 3% on a conventional loan, which is lower than the 3.5% required by an FHA loan.
Competitive mortgage insurance rates. The cost of PMI that kicks in if you don’t put at least 20% down may sound onerous, but it’s less expensive than FHA mortgage insurance and, in some cases, the VA funding fee
Higher maximum DTI. You’ll be able to stretch up to a 45% DTI, which is higher than FHA, VA or USDA loans typically allow.
Flexibility with property type and occupancy. This makes conventional loans a great alternative to government-backed loans, which are restricted to borrowers who will use the property as a primary residence.
Generous loan limits. The loan limits for conventional loans are often higher than for FHA or USDA loans.
Higher down payment than VA and USDA loans. If you’re a military borrower or live in a rural area, you can use these programs to get into a home with zero down.
Higher costs for DTIs over 40%. Although you can qualify with a 45% DTI, starting Aug. 1, 2023, borrowers with DTIs over 40% may pay increased interest rates or an extra fee at closing.
Higher minimum credit score: Borrowers with a credit score under 620 won’t be able to qualify. This is often a higher bar than government-backed loans.
Higher costs for certain property types and nonoccupying borrowers. Conventional loans come with increased fees for manufactured homes, second homes, condos, investment properties and two- to four-unit properties.
Frequently asked questions
A 620 score is the minimum needed to qualify for a conventional loan, but some lenders may set a higher minimum credit score threshold.
Loan limits are set by number of units and location. In 2023, the maximums for most U.S. counties are:
- One unit: $726,200
- Two units: $929,850
- Three units: $1,123,900
- Four units: $1,396,800
People who can’t qualify for a conventional loan due to a low credit score or a high <a href=”https://www.lendingtree.com/home/mortgage/calculate-debt-to-income-ratio/”>DTI ratio</a> will need to seek more flexible options. For those with excellent credit, a conventional loan is generally the most cost-effective option — but if your credit just barely qualifies, it can pay to do a little more research. In some cases, an FHA loan may be cheaper.
There are several programs that cater to borrowers who want a single conventional loan that will fund both the purchase of a fixer-upper and the renovation costs. Fannie Mae’s HomeStyle® Renovation loan allows down payments as low as 3%, and interest rates typically out-compete a home equity line of credit (HELOC) or personal loan. Freddie Mac offers a similar rehab loan, called the CHOICERenovation® mortgage, which is designed to be especially helpful for first-time homebuyers, seniors and multigenerational families.