7 Types of Conventional Loans
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 because it’s likely to provide less costly borrowing options.
THINGS YOU SHOULD KNOW
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 who don’t need a loan larger than current conforming loan limits.
Non-conforming or ‘jumbo’ loans
What are they? Non-conforming loan (also known as “jumbo” loans) are conventional loans that don’t stick to the guidelines issued by Fannie Mae and Freddie Mac, usually because they exceed maximum loan limits. This makes them riskier to 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.
What are they?Non-qualified 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 non-qualified mortgage, as long as they understand that these loans can have high rates and other uncommon features.
Who are they best for?Homebuyers who have a low credit score, a 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.
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 meet 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?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 (ARMs) have an interest rate that will change over the loan term. Although ARMs typically begin with an introductory period with a low interest rate (compared to a typical fixed-rate mortgage), borrowers should expect a rate increase after this period ends. Precisely how and when it will 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.
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 3% down. 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, but all offer 3% down loan options.
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 private mortgage insurance (PMI) or want to split their loan amount in order to avoid a “jumbo” loan.
Frequently asked questions
What credit score do I need to qualify for a conventional loan?
A 620 score is the minimum needed to qualify for a conventional loan, but some lenders may set a higher minimum credit score threshold.
What is the maximum amount I can borrow using a conventional loan?
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
Who shouldn’t take out a conventional loan?
People who can’t qualify for a conventional loan due to a low credit score or a high DTI ratio 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.
Are there conventional loans for fixer-uppers/home renovation?
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 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.