What is a conventional mortgage?
Financial institutions like credit unions, banks and other lenders often offer a variety of mortgage options. Many of these lending plans are government backed, meaning the loan is insured by a U.S. government agency, allowing the lender to issue more flexible credit guidelines as long as strict guidelines are met. For a more accessible lending option without added government stipulations, many buyers decide to apply for a conventional mortgage.
What is a conventional mortgage?
To get approved for a government-backed loan, you’ll usually have to meet some extra requirements, such as a history of military service. Most borrowers who don’t meet these stipulations opt for a more common form of financing, known as a conventional loan.
Conventional loans are mortgages that are not insured by any government agency, with the terms of the agreement settled between you and your lender. Among conventional loans are some of the most popular home loans in the mortgage industry, which we’ll get more into below.
Government-backed homes are designed to help more consumers achieve homeownership and include specific conditions that differentiate them from conventional mortgages. For example, you couldn’t use a VA loan to finance the purchase of a second home, while opting for a conventional loan frees you from this restriction.
Although your lender will likely require a higher credit score and more expensive terms than a government loan, a conventional mortgage opens you up to more financing opportunities. Without the restrictions set by outside government agencies, you’ll be able to secure a mortgage for a wider variety of property types without worrying about external regulations or program-specific fees.
You’ll also have more options to choose from when it comes to picking the right mortgage to help you buy a house.
Types of conventional mortgages
One of the major benefits of opting for a conventional mortgage is greater access to a wide variety of financing solutions. Here are some of the more common conventional loan packages you lender might be able to provide:
Fixed rate mortgages
One of the most popular mortgage structures is the conventional fixed rate loan. This type of financing establishes an interest rate that won’t change throughout the loan’s term. This guarantees a stable payment plan as you pay off the outstanding principal with the same payment from month to month.
A 30-year fixed mortgage, for example, might come with an interest rate around 3%. No matter what happens to the mortgage industry during the three decades of your amortization schedule, the amount you pay stays the same.*
Fixed rate loans can also be structured with shorter repayment periods, such as 10 or 15-year mortgages. While these financing plans also feature an unchanging interest rate, the repayment period is much shorter, meaning you’ll be paying more each month than you would on a 30-year plan.*
While some other mortgage structures adapt to current interest rates, a fixed mortgage means the amount you pay won’t budge. This added assurance allows you to plan out your financial future without the worry of unexpected economic changes impacting your mortgage payment.
Non-conforming jumbo mortgages
Jumbo loans are a type of conventional mortgage that can feature both fixed and adjustable rate options. Usually taken out to purchase a larger home, the amount taken out for these mortgages surpasses the Federal Housing Finance Agency’s, or FHFA’s cap, classifying jumbo loans as non-conforming mortgages.
The large amount of financing provided for jumbo loans means your lender takes on significantly more risk than they would normally, leading to a much higher threshold for approval than their conforming counterparts. Among other requirements, you’ll need an excellent credit score, few ongoing debts and lots of money in the bank in order to secure a jumbo mortgage.
Conforming loans vs. non-conforming loans
For most mortgages, the amount of financing cannot exceed the mortgage limits set by the Federal Housing Finance Agency. These limits help sustain liquidity and stability in the real estate economy and make mortgages available to a wider range of borrowers. As of 2021, the FHFA mortgage limit was $548,250.
While conforming loans adhere to the FHFA’s loan limits and underwriting guidelines established by Fannie Mae and Freddie Mac, non-conforming loans do not. These limits also grant lenders access to the secondary market, where mortgages can be packaged and sold to another institution.
Your lender is cut off from this secondary market when issuing a non-conforming loan. This adds plenty of risk for lenders and is reflected in the rigorous underwriting process and higher closing costs associated with this non-conforming conventional loans.
Adjustable rate mortgages
An adjustable rate mortgage, or ARM, is another type of conventional home loan that features a fixed interest rate for a set number of years, followed by periodic adjustments when the fixed rate term ends.
Usually expressed as two variables, such as “5/6” or “7/6,” the first number indicates how long the interest rate will be fixed, and the second represents how often it will be adjusted after the fixed rate period. A 7/6 ARM, for example, would set you up with a fixed rate agreement for the first seven years. When that term ends, the interest rate would be readjusted every six months.
Depending on your lender and what financing plans they provide, the fixed rate on an ARM can range from 1-10 years. When your rate is adjusted, your mortgage bill could be higher or lower than it was before, depending on the real-estate index and margins.
Government loans vs. conventional mortgages
Before you decide on which financing structure to pursue, it’s important to understand how government-backed loans differ from conventional mortgages. Let’s take a look at some common agency-insured loans and how they differ from conventional plans:
- FHA loans
- VA loans
- USDA loans
If you’d like to buy a home but don’t have the credit score or capital for a typical financing plan, FHA loans might be a good choice.
Since these loans are government insured, lenders can lower the threshold toward certain credit or property characteristics when approving a loan. If the buyer falls behind on payments and the home loan falls into default, the lender can sell it back on the market in order to recoup their losses. With a portion of their financing insured, banks can be more flexible with their mortgage approval terms, creating new paths to homeownership for borrowers who apply for an FHA loan.
FHA loans also come with expensive premiums and typically require mortgage insurance throughout the mortgage’s term.
VA loans were created to offer affordable mortgage plans for military veterans, active service members and their families by lowering some of the costs associated with buying a home.
Provided by the U.S. Department of Veterans Affairs, the program allows lenders to approve mortgages with more flexible eligibility requirements and repayment plans. As an eligible VA loan applicant, you’ll get the benefits of no down payment requirements, lower credit score minimums, comparatively lower interest rates and other purchasing perks that can only be accessed with a VA loan.
Similar to VA loans, USDA loans are designed to make it easier for qualifying families to invest in a home. Backed by the U.S. Department of Agriculture, USDA loans also assure creditors that their portion of the sales price is insured and can be more lenient toward approval.
However, USDA loans are intended to make housing accessible in mostly rural communities and can only be administered if the property’s location meets the USDA guidelines, so they might not be an applicable option for everyone.
Conventional loans might be a bit harder to get approval on, but without the roadblocks and added expenses of government-backing, you’ll have a wider variety of lending and property options to choose from.
Whether it’s a fixed rate, ARM or jumbo mortgage, there are plenty of conventional mortgages to choose from as you embark on the mortgage process.
*Sample rate provided for illustration purposes only and is not intended to provide mortgage or other financial advice specific to the circumstances of any individual and should not be relied upon in that regard. Guaranteed Rate, Inc. cannot predict where rates will be in the future