Seven Types of Conventional Loans
What You Should Know
- Government agencies do not insure conventional loans.
- There is more risk for lenders and a tougher qualification process.
- Most lenders require private mortgage insurance (PMI) with down payments below 20%.
- Conforming and non-conforming lenders will resell your mortgage, while portfolio lenders won’t.
Conventional loans are offered by private corporations rather than government-backed. There is more risk to your lenders because the government will not cover your payment if you default. This is why conventional loans tend to have stricter qualification criteria.
Namely, conventional loans require a higher credit score, lower debt-to-income ratio, and higher down payment. However, you can still get a traditional loan with a down payment below 20%. This article will compare the seven types of conventional loans to help you find the best option.
Understanding Conventional Loans
Banks or credit unions offer conventional loans and aren't backed by the government. They are riskier to your lender and require more creditworthy applicants. If you qualify for a conventional loan, you will typically pay less than a non-conventional loan. For example, non-conventional loans such as an FHA or VA loan have many upfront fees that will affect your cost of borrowing. What's important is comparing the mortgage APR, which includes all fees.
Three broad categories encompass the seven types of conventional loans. Note that you can mix the categories. For example, you can have a fixed-rate, non-QM loan from a portfolio lender.
|Category One: Loan Base Structure||Conforming Loan||Tough qualification process with low interest rates and fees. Lenders can sell the mortgages to Fannie Mae and Freddie Mac.|
|Non-Conforming Loan||Tougher qualification process for homes over the maximum conforming limit. Lenders can sell the mortgages but not to Fannie Mae or Freddie Mac.|
|Non-Qualified Mortgage (Non-QM)||For borrowers that can't qualify for other mortgages. Typically have a higher interest rate with exciting features.|
|Category Two: Additional Features||Fixed Rate Mortgage||The interest rate stays the same throughout the whole term. Offers predictability.|
|Adjustable Rate Mortgage (ARM)||A lower initial fixed interest rate that eventually adjusts to a benchmark.|
|Low Down Payment||Mostly for low-income borrowers to buy a house with a minimum 3% down payment.|
|Category Three: Type of Lender||Portfolio Loans||Mortgages are held by the lender rather than sold on the secondary market. Lenders have more flexibility with qualification guidelines.|
Types of Conventional Loans: Loan Base Structure
A conforming loan "conforms" to the guidelines set by Fannie Mae and Freddie Mac. These government-sponsored enterprises (GSEs) purchase mortgage debt from lenders, which provides more money to originate mortgages.
Since lenders have guaranteed investors, they are more willing to lend to conforming loan applicants. As a result, conforming loan mortgages typically have low interest rates and fewer fees. For a loan to meet GSE requirements, it must meet the following criteria:
- Mortgage size below your regional conforming loan limit
- 3% to 20% minimum down payment
- 620 minimum credit score
- 45% to 50% maximum debt-to-income
A non-conforming loan doesn't meet the guidelines set by Fannie Mae and Freddie Mac. This means lenders can't sell the mortgage to these GSEs. However, lenders can still sell non-conforming loans to mortgage investors if they wish to.
The most common type of non-conforming loan is a jumbo loan. Jumbo loans are for borrowers who need a loan amount higher than the limit Fannie Mae and Freddie Mac set. The qualification criteria are even tougher, and you'll likely need a larger down payment percentage. To qualify for a jumbo loan, you'll need to exceed the following criteria:
- Mortgage size above the regional conforming loan limit
- 20% minimum down payment
- 700 minimum credit score
- 43% maximum debt-to-income
A non-qualified mortgage (non-QM) is any home loan that doesn't meet the guidelines set by the Consumer Financial Protection Bureau. They are typically meant for people who can't qualify for the prior two options. However, non-QM mortgages allow many self-employed individuals to buy houses.
Non-QM loans are riskier for lenders and typically have higher interest rates and fees. Some examples of non-QM loans are as follows:
- Balloon Mortgage: These have one large payment due at the end of the term.
- Interest-Only Mortgage: Make monthly payments on the interest accrued on your loan. At the end of the term, pay back your initial amount.
- DSCR Loan: Acquire an investment property using the future rental income you will receive.
- Chattel Mortgage: Ability to purchase movable property such as mobile homes.
Types of Conventional Loans: Additional Features
After selecting your loan base structure, you can decide on your type of mortgage interest rate. Your interest rate will directly influence your monthly mortgage payment. A higher interest rate will increase your payment. There are generally two interest rate options; fixed or adjustable rate.
|Adjustable-Rate Mortgage (ARM)|
|Low Down Payment|
A fixed-rate mortgage has an interest rate that remains the same for the life of the loan. The most common term for a fixed-rate mortgage is 30 years. With a fixed-rate mortgage, your monthly payment will not change over the life of the loan. They are great for borrowers who prefer predictability.
An adjustable-rate mortgage (ARM) begins with a fixed interest rate period that eventually becomes adjustable. The initial fixed period is typically lower than what you would get from a fixed-rate mortgage. However, your adjustable interest rate may rise above.
ARMs are frequently stylized with a fixed period and adjustable period. For example, a 3/1 ARM means that you have a fixed interest rate for the first three years, and your interest rate will adjust yearly to the benchmark.
If you prefer a more extended initial fixed period, you can choose a 5/1, 7/1, and 10/1 or more. You can also select the frequency at which your adjustable rate changes. For example, if you chose a 5/5 ARM, your initial rate would be for five years. Afterward, your interest rate would adjust to the benchmark every five years. This provides more predictability while still benefiting from the lower initial interest rate.
Low Down Payment Conventional Mortgage
While the most common way to get a low-down mortgage is through the governmental FHA loan, conventional alternatives exist. You can still get a conventional mortgage if you don't have much money for a down payment. You can put down as little as 0% to 3%. Some lenders may even allow you to finance fees with a no-closing cost mortgage.
Note that if your down payment is lower than 20% for conventional mortgages, you will likely need private mortgage insurance (PMI). This ranges from 0.55% to 2.25% of the original loan amount. Since the government is not backing your mortgage, this will protect your lender if you default. You can also pay it upfront or roll the costs into your mortgage. Once you have built 20% equity in your home, you can refinance your mortgage or ask your lender to remove PMI costs. Otherwise, your lender will automatically remove PMI when you reach 22% home equity.
3% down payment
Fannie Mae and Freddie Mac offer mortgages up to a 97% loan to value (LTV) through their HomeReady and Home Possible programs. While these options require a higher credit score than non-conventional FHA loans, you'll save on the mortgage insurance premium (MIP). However, both programs have maximum income limits
- Fannie Mae HomeReady: Qualifies candidates based on their overall creditworthiness. Ideal candidates have a credit score exceeding 620 and an income up to 80% of their area median.
- Freddie Mac Home Possible: Designed for very-low to low-income borrowers.
0% down payment
While 0% down conventional payment loans are possible, they are tough to find. However, some lenders, such as credit unions, may offer 100% financing on their portfolio loans. These options are typically only available to credit union members and require a direct deposit with the lender.
A portfolio lender is a bank or other financial institution that lends money from its funds rather than selling the loan to another company. They are typically credit unions or smaller community banks. Portfolio lenders keep loans on their books and service them for the life of the loan. As a result, portfolio lenders set their lending criteria. You may be able to get a loan that you wouldn't qualify for with a traditional lender.