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Conventional Loans
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A conventional loan is a type of mortgage loan that is not insured or guaranteed by the government. Instead, the loan is backed by private lenders, and its insurance is usually paid by the borrower. Conventional loans are much more common than government-backed financing making up around two-thirds of all U.S. mortgages. These loans are packaged and sold on the secondary market.
Though conventional loans offer buyers more flexibility, they may be more difficult and/or costly to obtain for a less-qualified borrower. Conventional loans can be used to buy investment property. There are two types of conventional loans, conforming and non-conforming.
Conforming Conventional Loans
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Since mortgages can take up to 30 years to pay off, mortgage lenders typically can’t afford to wait for a full mortgage term to get that money back; they need cash flow to continue to lend new mortgages to home buyers.
To provide that cash flow, investors purchase mortgage notes from lenders. The investor may keep a small number of mortgages in its portfolio, and the rest will be securitized and sold on the bond market.
The largest buyers of conventional mortgages are Fannie Mae and Freddie Mac. These two companies are government-sponsored enterprises. This means that, while they operate independently of the government, they are subject to some supervision that ensures that they’re operating in a responsible way. The government agency that supervises Fannie and Freddie is called the Federal Housing Finance Agency.
Fannie and Freddie have standards for the types of mortgages they’ll buy, to ensure that the mortgage market is made up of creditworthy mortgages. If a mortgage fits within their standards and is eligible to be bought by one of these GSEs, it’s considered to be a conforming loan.
Non Conforming Conventional Loans
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Non conforming loans are ineligible to be sold to Fannie Mae or Freddie Mac. When a lender makes a non conforming loan, they may hold it in their portfolio or sell it to a private investor. The most common type of non conforming loan is a jumbo loan.
Each year, the FHFA publishes limits for the maximum loan amounts for conforming loans. In most areas in the U.S. in 2021, you can’t get a conforming loan for an amount larger than $548,250. In some areas that have been deemed “high cost” (Los Angeles or New York City), the limit is $822,375.
If you want to use a mortgage to purchase a house that costs more than your area’s conforming loan limit you’ll have to get a jumbo loan.
Nonconforming loan requirements are left up to individual lenders, and can vary depending on what type of loan you’re getting. With a jumbo loan, you can expect lenders to have stricter approval requirements than with conforming loans.
Qualifications
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You will need a down payment to qualify for a conventional loan. Though you can put as little as 3% down when you get a conventional loan, a lower down payment requires PMI (private mortgage insurance). With 20% down you can avoid paying PMI.
You may have a fixed or adjustable rate. With a fixed rate, your interest remains the same throughout the life of the loan, from your first payment to your last. With an adjustable rate, the rate is periodically modified based on the market.
Your initial interest rate is determined by a combination of different factors, including market conditions, the type of loan you’re getting, the amount you’re borrowing and your creditworthiness. To get the best rate possible, you may want to first take some time to improve your credit score, lower your DTI (debt to income ratio) or save more money for a down payment before applying for a mortgage.
