Conventional Loans: Requirements, Types And Rates
*As of July 6, 2020, Rocket Mortgage® is no longer accepting USDA loan applications.
You might be surprised at the many choices you have when searching for a mortgage loan to help finance the purchase of a home.
You can choose from loans insured by the federal government, such as FHA or VA loans. You can select a mortgage with an interest rate that never changes or one with a rate that rises and falls throughout your loan's term. You can choose a loan that you pay off in 30 years or one that you'll pay down in just 10 or 15 years of regular monthly payments.
Here we’ll go over the different types of mortgages so you can make the right decision.
What Is A Conventional Loan?
A conventional mortgage is any home loan not insured by a federal government agency such as the U.S. Department of Veterans Affairs, U.S. Department of Agriculture or Federal Housing Administration. These loans are originated and serviced by private mortgage lenders, a group that includes credit unions, banks and other financial institutions.
If you are applying for a loan that isn't insured by a federal agency, you're probably applying for a conventional mortgage.
Conventional mortgage loans can be divided into two basic categories: conforming and nonconforming.
If a loan can be purchased by Fannie Mae or Freddie Mac, it is a conforming loan. Otherwise, it’s a nonconforming loan. Conforming loans must follow certain guidelines that the entire mortgage industry is subject to, while the guidelines for nonconforming loans are decided by individual lenders.
Conforming Conventional Loans
It can take homeowners a long time to pay off their mortgages. One of the most common types of loans, after all, is the 30-year, fixed-rate mortgage. As the name suggests, homeowners who hold this mortgage type for its full term will take three decades to pay it off.
Mortgage lenders typically don't want to wait three decades– or 15 or 10 years for shorter-term loans – to get back the money, with interest, that they lend to homeowners. Lenders need a more consistent cash flow if they want to continue lending money to home buyers.
To help provide that cash flow, lenders often sell their mortgage loans to investors. These investors might keep a small number of mortgages in their portfolio while selling the rest on the bond market. These sales from lenders to investors keep the cash flowing to mortgage lenders.
The largest buyers of conventional mortgages are Fannie Mae and Freddie Mac, both of which are government-sponsored enterprises. While both Fannie and Freddie operate independently of the federal government, the agencies must follow certain rules to ensure that they operate in a responsible way. The federal Housing Finance Agency, or FHA, is the government agency that oversees Fannie and Freddie.
Fannie and Freddie have standards for the types of mortgages they’ll buy. Their goal is to make sure that the mortgage market is filled with creditworthy mortgages. If a mortgage fits within their standards and is eligible to be bought by Fannie Mae or Freddie Mac, it’s considered to be a conforming loan.
A conforming mortgage loan must also meet certain size limits imposed each year by the Federal Housing Finance Agency. For 2022, mortgages for most one-unit homes across the United States can be as high as $647,200 and still be considered conforming. Mortgages over this amount will be considered jumbo loans and are no longer categorized as conforming loans.
Jumbo loans typically come with higher interest rates and require larger down payments. Borrowers will typically need higher credit scores.
In certain higher-cost areas of the United States, including cities such as New York City, Los Angeles and San Francisco, the conforming loan limit is even higher. For 2022, mortgages for one-unit homes in these high-cost areas can be as high as $970,800 before they are considered nonconforming jumbo mortgages.
The big difference between conforming and nonconforming conventional loans is that lenders can't sell nonconforming mortgage loans to Fannie Mae or Freddie Mac, reducing the selling opportunities for these loans. Lenders can sell nonconforming mortgage loans to private investors.
The most common type of nonconforming loan is a jumbo loan. If you want to finance the purchase of a home with a mortgage that is higher than your area's conventional loan limits, you must apply for a nonconforming loan.
The requirements borrowers must meet for nonconforming loans will vary by individual lender. In general, though, borrowers will need both higher down payments and credit scores to qualify for a nonconforming loan. These loans usually come with higher interest rates, too.
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Conventional Loan Requirements
Ready to apply for a conventional mortgage loan? You'll need to first meet certain requirements, especially if you're applying for a conforming conventional mortgage.
Lenders will consider such factors as your three-digit FICO® credit score, debt-to-income ratio and the size of your down payment when deciding whether to approve your loan request.
Here's a look at what you'll typically need to qualify for a conventional mortgage loan.
You’ll need to bring at least some amount of money for a down payment when you apply for a conventional mortgage loan.
How much down payment money you’ll need varies.
You can qualify for conventional mortgage loans with down payments as low as 3% of your home’s final purchase price through certain Fannie Mae and Freddie Mac programs. Just ask your mortgage lender if you qualify. You can also qualify for conventional mortgage loans with down payments as low as 5% of a home’s sales price.
If you can afford it, though, it usually makes more financial sense to come up with a larger down payment. If you can come up with a down payment of at least 20% of your home’s final purchase price, you won’t be required to pay for private mortgage insurance, a type of insurance that protects your lender if you stop making your mortgage payments.
That’s a big down payment, though. For a home with a final sales price of $220,000, a down payment of 20% comes out to $44,000. Many home buyers don’t have that kind of money available, which is why many instead come up with down payments of 5% or 3% of a home’s final price. A 5% down payment on that same home costing $220,000 comes out to $11,000, still a large sum of money but not nearly as intimidating as $44,000.
Just remember, if you come up with a larger down payment, you’ll typically pay a lower interest rate on your mortgage.
Your FICO® credit score is a key number when you apply for a mortgage loan. This three-digit number summarizes how well you’ve managed your credit and paid your bills. The higher your credit score – lenders consider FICO® Scores of 740 or higher to be excellent ones – the better your chances of qualifying for a mortgage loan with a low interest rate.
To build a strong credit score, pay your bills on time each month and pay down your credit card debt. Several of your monthly payments – including those for your mortgage, auto loan, student loan, credit cards and any personal loans – are reported to the three national credit bureaus of Experian®, Equifax™ and TransUnion®. Pay these bills on time each month, and you’ll steadily build your credit score. Pay them 30 days or more past their due dates, though, and your score could fall by 100 or more points.
Don’t panic if your credit score isn’t 740 or higher. Lenders will vary, but many will approve you for a conventional mortgage with a credit score of 620 or higher. Just expect a higher interest rate if your FICO® Score is closer to 620 than 740.
Another key number when applying for a mortgage? Your debt-to-income ratio, a figure that measures how much of your gross monthly income your monthly debts eat up.
In general, lenders want your total monthly debts, including your estimated new mortgage payment, to equal no more than 36% of your gross monthly income. If your debt-to-income ratio is higher, you might have to pay higher interest rates to make up for some of the risk that lenders are taking on when loaning you mortgage money.
What’s The Difference Between FHA Loans And Conventional Loans?
FHA loans, like other nonconventional loans, are insured by the government, in this case the Federal Housing Administration. FHA loans typically have lower credit requirements and allow for down payments as little as 3.5% of your home's final purchase price.
To qualify for this lower down payment, you’ll need a FICO® credit score of 580 or higher. If your FICO® Score is at least 500, you can qualify for an FHA loan with a down payment of 10% of your home's final price. Just remember: Private mortgage lenders originate FHA loans, and some won't approve you for a loan if your FICO® Score is too low, even if the FHA would allow it.
Other types of government-insured, nonconventional loans include VA loans, which are insured by the U.S. Department of Veterans Affairs and are limited to qualifying service members, veterans and surviving spouses; and USDA loans, which are insured by the U.S. Department of Agriculture and are available to home buyers in certain rural and suburban areas.
Rates For Conventional Loans
When applying for a mortgage loan, you’ll want to know what interest rate your lender will assign you. Your interest rate is a key factor in determining how much you’ll spend each month in paying down your mortgage.
With a higher interest rate, your mortgage payment will also be higher each month. A lower interest rate will mean a lower payment.
How do you qualify for the lowest interest rate? It helps to have a strong FICO® credit score, a low debt-to-income ratio and a higher down payment.
Depending on your loan type, your interest rate will remain the same throughout the life of your mortgage or will rise and fall over time.
With a fixed-rate mortgage, your interest rate stays the same throughout the life of your mortgage. The interest rate on your first monthly payment is same as the one with your last.
An adjustable-rate mortgage is more complicated. With these loans, your initial interest rate is typically lower than what you’d get with a fixed-rate loan. This lower rate stays in place usually for 5 – 7 years. After that, the rate rises and falls according to whatever economic index a loan is tied to. Typically, the interest rate on an adjustable-rate mortgage will adjust after the fixed period ends.
The Bottom Line
Is a conventional mortgage the right choice for you? That depends. Typically, if you have a higher credit score, you can qualify for a conventional loan that comes with a lower interest rate than what you’d get with a government-insured mortgage. But if your credit is weaker and you don’t have much money for a down payment, a government-insured loan might be the better choice.
If you are interested in applying for a mortgage – conventional or otherwise – you can get started by filling out an application with Rocket Mortgage® today.