A conventional loan is any mortgage loan that is not guaranteed or insured by a government entity. It is also the most common type of mortgage loan and likely the first thing that comes to any homebuyer’s mind when they need to apply for a loan.
Conventional loans are provided through private lenders, banks or credit unions. In general, buyers are required to have a minimum credit score of 620 to qualify for a conventional loan, with a debt-to-income (DTI) ratio of 43% or less. Conventional loans come in different shapes and sizes, each with its own benefits. Here are the most common types to look out for:
These mortgages span several years and feature an interest rate that stays the same for the duration. This ensures that your monthly payments are predictable, making it much easier to budget for them. However, the duration of the loan impacts how high the monthly payments will be:
- A 30-year fixed-rate mortgage is among the most common and is ideal for homebuyers looking for smaller monthly payments.
- A 15-year fixed-rate mortgage allows you to pay off your loan in half the time, but your monthly payments will be significantly higher. On the plus side, the interest rate is typically lower than a 30-year mortgage, and you’ll pay less in total interest payments. These shorter-term loans are great for refinancing and for buyers with a bit of spare change in their pockets.
The minimum duration of a conventional loan is 5-years, ideal for those buyers that want to avoid paying too much in interest and have the cash available for larger monthly payments.
The interest rate on an adjustable-rate mortgage is variable, fluctuating over time. This can be great if interest rates drop but an expensive gamble if they increase throughout the term of your loan. However, the introductory rate is typically far lower than most fixed-rate mortgages, resulting in sometimes drastically lower monthly payments. In addition, it’s locked in place for either 1, 3, 5, 7, or 10 years.
After this initial rate, it will adjust periodically, often annually, though different schemes can be discussed with your lender. Adjustable-rate mortgages are available for various lengths and are ideal for buyers who believe that rates will drop in the future.
Most unconventional loans are backed by a government entity. They are designed to help segments of the population that might otherwise find it hard to qualify for a conventional loan. Here are the most common types of unconventional mortgage loans.
Insured by the Federal Housing Association, FHA mortgages are aimed at buyers who don’t meet the credit score or DTI ratio requirements of conventional loans. It’s possible to obtain an FHA loan with a credit score as low as 500, though you’ll need 580 to put down a down payment of as little as 3.5%. FHA loans are great for first-time buyers and experienced buyers alike with lower credit scores looking to avoid a 20% down payment.
Guaranteed by the Department of Veterans Affairs, VA loans are designed to help serving and veteran members of the military and their spouses. There are several benefits, including no down payment, no mortgage insurance requirement and competitive interest rates. You will need to pay a VA funding fee, either upfront or rolled into your mortgage payments. This is a relatively modest cost ranging from 1.4% to 3.6%,depending on how much your down payment is.
Backed by the U.S. Department of Agriculture, USDA loans are designed to ‘improve the economy and quality of life in rural America.’ Only buyers seeking properties in rural areas will qualify, though there are other criteria to meet. USDA loans don’t always require a down payment and provide caps on property prices and income limits. Ideal for buyers looking to settle down in the country.
Conforming and Non-Conforming Mortgages
The loans discussed above fall into the category of conforming loans. These adhere to the loan limits set by the government (Federal Housing Finance Agency – FHFA). In addition, conforming loans meet the underwriting guidelines set by Fannie Mae and Freddie Mac.
Non-conforming mortgages, on the other hand, exceed the limits set by the FHFA and do not conform to guidelines. Jumbo loans are the most well-known type.
These are reserved for buyers who meet the strictest criteria, with a minimum down payment of at least 20% and a higher credit score (at least 700) and DTI requirements. They’re designed to finance expensive properties in which conforming loan limits would be breached. Jumbo loans are suitable for buyers of expensive homes who have the funds and credit reliability to make the high repayments.