*As of July 6, 2020, Quicken Loans is no longer accepting USDA loan applications.
As you go through the home buying process, you may be surprised to find that on top of finding a mortgage lender who’s willing to give you the money you need to buy a home, you’ll also have a small variety of loan options from which to choose. Who knew that mortgages came in so many different, and often confusing, flavors?
To a home buying newbie, figuring out which type of loan makes the most sense for you can seem overwhelming. You may have heard of a “conventional” mortgage loan, but aren’t exactly sure what that means. No worries. We’ll walk you through what, exactly, a conventional loan is.
What Is A Conventional Loan?
Some mortgage loans are insured by the government, so if the borrower defaults on the loan, the lender is protected from the loss.
Conventional loans are loans that aren’t insured by the government.
Conventional mortgage loans can be divided into two basic categories: conforming and nonconforming. If a loan is eligible to be purchased by Fannie Mae or Freddie Mac, it is a conforming loan. Otherwise, it’s a nonconforming loan. We’ll get more in-depth into those distinctions in a minute (and who Fannie and Freddie are), but for now, just know that conforming loans have to follow certain guidelines that the entire mortgage industry is subject to, while the guidelines for nonconforming loans are decided by individual lenders.
Conventional Loan Requirements
Let’s take a look at what the criteria are for qualifying for a conforming conventional loan as set forth by Fannie Mae and Freddie Mac. For our purposes, we’re strictly talking about single-unit purchase transactions for a primary residence – essentially, a typical home purchase.
We’ll also try to give you an idea of what requirements for a nonconforming loan can look like, but you’ll have to speak with lenders individually to find out if you meet their specific requirements for a nonconforming loan.
Keep in mind, too, that the conforming loan guidelines only dictate which types of loans Fannie and Freddie will purchase; lenders are also allowed to have their own requirements for the loans they provide, as long as they don’t conflict with the conforming loan guidelines. So it’s possible to find lenders that have more stringent requirements than those listed here.
When you get a conventional loan, you’ll almost always have to bring a certain amount of cash to the table yourself; you can’t fund the transaction entirely with a loan. Making a down payment ensures that you have a stake in the home, which translates to less risk for the lender.
Both Fannie and Freddie have programs that allow you to put down as little as 3% of the home’s total price. However, if you don’t qualify for a 3% down option, you’ll likely have to put down at least 5% of the home’s price – possibly more.
If you make a down payment below 20%, you’ll be required to pay for mortgage insurance, which helps protect the lender in case a buyer defaults. However, you’ll be able to have your mortgage insurance removed once you reach 20% equity in your home.
With nonconforming loans, you can usually expect minimum requirements for a down payment to be larger, though it depends on the lender and the features of the loan. If your loan is nonconforming because you’re borrowing a sum that is larger than what is typically allowed with conforming loans (also known as a jumbo loan), for example, you may have to put down at least 10%, possibly more.
For conforming loans, you’ll generally need a credit score of at least 620 to be eligible for mortgage approval, though individual lenders may require a higher score.
While 620 is the lowest you can go for conventional loans, you may need a higher score if you have other factors that heighten your credit risk, such as a high debt-to-income ratio or a small down payment.
When it comes to nonconforming loans, the required credit score will depend on what type of loan you’re getting. If you’re applying for a nonconforming loan that’s aimed at borrowers with poor credit history, the credit requirements may be more lenient. However, if you’re applying for a jumbo loan, a higher-than-average credit score will likely be required.
Your debt-to-income ratio is the comparison of your monthly debt obligations (including any debts you currently owe plus your proposed future mortgage payment) to your gross monthly income. In general, it’s best to try and keep your DTI below 36%, especially if you want to get a good rate on your mortgage.
You can get a mortgage with a larger DTI, but you’ll likely need to otherwise have a strong application (including a good credit score, a substantial down payment and a certain amount of cash reserves) to be qualified and still snag a decent interest rate.
In fact, it’s possible to get a conventional, conforming mortgage with a DTI up to 50%. However, just because Fannie and Freddie will buy a mortgage with a 50% DTI doesn’t mean that a lender has to offer it, so you may have to shop around to find a lender that will work with you.
DTI requirements for nonconforming loans may be lower than the requirements for conforming loans. For example, an individual lender may cap DTI at 45% or lower for their nonconforming loans.
Types Of Conventional Loan
As we’ve already mentioned, there are two types of conventional loans. Let’s get a little more detail on what distinguishes those two types, and who the heck Fannie and Freddie are.
Conforming Conventional Loan
To understand conforming loans, you need to know a little bit about how the mortgage market works.
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.
Nonconforming loans are ineligible to be sold to Fannie Mae or Freddie Mac. When a lender makes a nonconforming loan, they may hold it in their portfolio or sell it to a private investor.
The most common type of nonconforming 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” (think 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.
As we’ve already talked about, 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.
Conventional Loan Rates
Depending on what type of loan you have, 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 or save more money for a down payment before applying for a mortgage.
FHA Vs. Conventional Loans
FHA loans are a popular alternative to conventional loans, especially for lower-income borrowers or borrowers whose credit doesn’t quite meet the requirements for a conventional loan.
FHA loans, like other nonconventional loans, are insured by the government – specifically, the Federal Housing Administration. FHA loans typically have lower credit requirements and allow for down payments as little as 3.5%. To get the lowest down payment option, you’ll need a credit score of at least 580. Some FHA lenders allow you to have a lower score, but you’ll have to provide a larger down payment to make up for 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.
Liquidity for these loans is provided by the investor Ginnie Mae, which works like Fannie Mae and Freddie Mac, but for government-insured loans.
Is A Conventional Loan Right For You?
The best loan for you is going to depend on a variety of factors related to your own personal financial situation. Be sure to take the time to look over your finances and credit history to determine what might make the most sense for you, and consider talking to a mortgage lender to learn more about your options.
If you’re interested in starting the process to get a mortgage, you can apply with Rocket Mortgage® by Quicken Loans®.