Current mortgage rates are low, making the path to homeownership a reality for a wide group of potential homebuyers. Not only are rates low, but there are many different types of mortgages to choose from that come with low rates. Conventional loans are the most common, but what is a conventional loan, and more importantly, is it the right home financing solution for you?
Conventional loans are a type of mortgage that is not guaranteed or insured by any government agency and is issued by a private mortgage lender or bank. This type of loan accounts for over 71% of all U.S. mortgages and often has a fixed interest rate and term. Conventional loans require most buyers to have a credit score of 620 or higher and a substantial down payment to avoid paying for extra insurance. There are, of course, exceptions to those rules, however.
If you’re on the market for a home loan and have a good credit history, minimal debt, sufficient income and can afford a larger down payment, a conventional mortgage might be a good option for you. Still, it’s important to know the ins and outs of this type of loan before making the choice.
What is a conventional loan?
Lenders rely on your creditworthiness and other criteria to qualify you for a conventional loan. Conventional loans can require a high credit score, a large down payment — usually 10% to 20% of the total home value — and may require costly private mortgage insurance if you can’t afford to put down the full 20% on a home. PMI gives lenders peace of mind by protecting their investment should you default on the loan. PMI can be costly, though, and is often required until your balance has been paid down to 80% of the home value. If you have to pay PMI, you’ll be required to pay for a mortgage premium when you close and a monthly premium that will be tacked onto your regular payment as well. If you can afford to put down at least 20%, though, most lenders often won’t require the monthly PMI.
Credit score requirements for conventional loans vary by lender, but you’ll need a minimum score of 670 to satisfy a lot of conventional mortgage lenders and garner lower interest rates on loans. That doesn’t mean that you won’t qualify for a conventional home loan with a lower score, but you’ll probably pay more in interest if your credit score is lower.
How conventional mortgages work
Conventional mortgages originate from a lender and come in a variety of terms depending on the loan amount, the amount of the down payment, the credit score and a ton of other factors, including the debt-to-income ratio.
Most conventional loans have 15-year and 30-year fixed-rate terms with an annual percentage rate that is locked in for the duration of the term. Lenders also offer adjustable-rate mortgages with terms that vary by lender, but some of the most common ARMs include 5/1, 7/1 and 10/1 terms. The rates for ARMs remain fixed for the first several years of the term and adjust according to the market each year after.
Down payment requirements are often the same for both fixed-rate and ARM mortgages. Most lenders require at least 10% to 20% down no matter what the terms of the loan are, but there are exceptions, and some lenders will accept a 5% down payment for well-qualified buyers. Remember, though, that any down payment of less than 20% will likely require you to pay a PMI. If you can afford to wait, it might be better to save for a larger down payment and avoid the PMI entirely.
Conforming vs non-conforming home loans
You should know that not all conventional loans are the same. There are two varieties: conforming and non-conforming loans. The type that’s right for you will depend on your situation and your budget.
Conforming loans are the most common type of conventional loans and the standards for this type of loan are set by Fannie Mae and Freddie Mac. There are caps on how much you can borrow with a conforming loan. The maximum loan for most areas across the country was raised to $484,350 recently, though there are exceptions for areas where the average home value exceeds that amount. In these areas, the maximum loan amount can be as high as $726,525.
Non-conforming loans are commonly referred to as “jumbo” loans and are meant for home purchases that exceed conforming loan limits. Non-conforming mortgages cannot be purchased by Fanny Mae or Freddie Mac and often carry more of a risk to the lender. Due to that higher risk, jumbo loans often come with a higher interest rate than conforming loans. Lenders may also require a higher credit score to qualify, among other more stringent criteria.
When a conventional home loan makes sense
Conventional mortgages are not backed by the federal government like FHA loans, VA loans and USDA loans are because the stricter criteria reduces the risk to lenders. It is possible to secure a conventional loan with a 5% down payment, but most lenders will want 10% to 20% down to fund a loan. It’s important to keep in mind that even if a lender will accept less than 20% down, any down payment of less than that will likely require the addition of PMI.
If you are low income, a veteran or plan to live in a rural area, government-backed loans might be a good option over a conventional loan. These loans often require a minimum credit score of 580 but you can often get away with making a smaller minimum down payment or potentially no down payment at all. Some borrowers might even qualify for down payment assistance on these loans.
The bottom line
If you’re ready to start your path to homeownership, begin by evaluating your current financial situation. An online calculator can help you determine how much mortgage you can afford. Take a good look at your credit report. You can request a free credit report from all three credit reporting agencies once per year. If you find any discrepancies, dispute them with the reporting agency.
Removing errors can bump your credit score up a notch and may help you qualify for better rates.
Learn what you can about the different types of mortgages and compare rates among top lenders. The APR with one lender will often differ from another and shopping around can help you find the best mortgage rate, conventional loan or otherwise.