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Robert R. Johnson, Ph.D., CFA, CAIA, is a professor of finance at Creighton University and chairman and CEO of Economic Index Associates, LLC.
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When you start shopping for mortgages to buy a home, you’ll encounter many options, including conventional loans. They’re the most common kind of home loan out there, available from virtually every type of mortgage lender. But what is a conventional mortgage, exactly? Here’s everything you need to know about Americans’ favorite tool for financing a home purchase.
A conventional loan is a mortgage that’s available through and backed by a private sector lender. Government-insured loans, by comparison, are backed or guaranteed by a federal agency. These include FHA loans, VA loans and USDA loans.
Conventional conforming mortgages were the most common mortgage type in Q4 of 2023, making up 44.8% of all originated mortgages, according to the Urban Institute.
Conventional mortgages are available through different types of mortgage lenders, including banks, credit unions and online mortgage companies. They come in two main types: fixed-rate or adjustable-rate.
To be approved for any type of mortgage, you’ll need to meet the lender’s requirements around your financials, including your credit score, income and debts. Conventional loan requirements tend to be stricter than government-backed loan requirements. Specific qualifications include:
Mortgages that fall within the FHFA’s limits are called conforming loans. This means Fannie Mae and Freddie Mac, two government-sponsored enterprises, can buy them on the secondary mortgage market. By selling these types of loans to Fannie and Freddie, lenders obtain the capital to continue to make new mortgages.
All conforming loans are conventional loans, but not all conventional loans are conforming loans. For example, if you get a jumbo loan — one whose size exceeds the FHFA limits — from a private bank, it would be a nonconforming conventional loan.
Mortgages that exceed conforming limits are called jumbo loans. A type of nonconforming loan, these are loans that can’t be sold to Fannie or Freddie, but they are still available to well-qualified borrowers who need a more flexible financing option. Jumbo loan rates tend to be higher than what you’d see with a smaller mortgage, though the gap has been closing in the last few years.
Non-qualified mortgages, or non-QM loans, also cannot be purchased by Fannie or Freddie. But they can be an option for those who are able to afford a mortgage but maybe are unable to meet the credit or DTI requirements. These borrowers tend to fall outside of the “ability to repay” guidelines established by the Consumer Finance Protection Bureau after the 2008 financial crisis, which indicate whether a borrower is likely to repay a mortgage.
One type of non-QM loan could be a portfolio loan. With this kind of loan, a lender keeps the mortgage on its books, rather than sell it. Because it doesn’t have to meet conforming loan standards, the lender can be more flexible when qualifying a borrower. It’s important to note, though, that non-qualified mortgages often come with higher interest rates.
Behind conventional conforming mortgages, portfolio mortgages were the second most common mortgage originated in Q4 of 2023, according to the Urban Institute, accounting for 27.6 percent of all new mortgages.
Subprime loans are generally for borrowers with lower credit scores (typically below 600) who can’t qualify for a conventional mortgage. Subprime loans tend to have higher interest rates and larger down payment requirements than conventional loans to compensate lenders for accepting added risk.
Fixed-rate loans keep the same interest rate — and same payment — over the life of the loan. An adjustable-rate mortgage (ARM) usually starts with an introductory “teaser” rate for the first few years. After that, the interest rate fluctuates periodically, so your monthly payment can go up or down.
Amortized loans have set, periodic payments that go toward the principal and interest until the loan balance is zero. While the monthly payment stays the same, you pay more in interest than principal at first and gradually shift to paying more principal than interest over time.
FHA loans, insured by the Federal Housing Administration (FHA), are ideal for borrowers with less-than-perfect credit, but they come with a less-than-ideal cost: mortgage insurance that cannot be removed – unless you make a down payment of 10 percent or more. Even then, you’ll have to wait 11 years until you can cancel it. (This applies to loans originated after 2013. The rules are different for older loans).
VA loans — guaranteed by the U.S. Department of Veterans Affairs — are available to military service members, veterans and their spouses. There are some additional steps to obtaining this type of mortgage, though, including getting your certificate of eligibility from the VA.
USDA loans — guaranteed by the U.S. Department of Agriculture— can be a viable option if your annual income doesn’t exceed a certain amount and you’re looking to buy a home in an area that meets USDA guidelines.
There are steps you need to follow to get a conventional mortgage.
Market factors like inflation, the Federal Reserve’s monetary policy, the bond market and the overall economy affect conventional mortgage rates, which change frequently. However, the rate you’re offered is largely determined by your credit score, down payment size and the type of loan you choose. You’ll generally get the best rate the higher your credit score and down payment.
Yes, you can get down payment assistance with a conventional mortgage. There are many different types of down payment assistance — consult with a lender or your local housing agency to see what might be available to you.
You pay mortgage insurance on a conventional loan until you have at least 20 percent equity in your home. At this point, you can request to have mortgage insurance removed. Lenders are legally obligated to remove PMI when your equity reaches 22 percent of the home’s value when the mortgage was written, or at the halfway point of your loan term.
Andrew Dehan writes about real estate and personal finance. His work has been published by Rocket Mortgage, Forbes Advisor and Business Insider. He’s also a poet, musician and nature-lover. He lives in metro Detroit with his wife and children.
