A conventional mortgage is a homebuyer’s loan made through a private lender. This type of loan isn’t offered or secured by a government entity—such as with Federal Housing Administration (FHA) loans. Instead, conventional mortgages are available through private lenders such as banks, credit unions, and mortgage companies.
In some cases, conventional mortgages can be guaranteed by the two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac.
Key Points to Remember
- A conventional mortgage isn’t backed by any government entity.
- Typically available through private lenders or guaranteed by Fannie Mae and Freddie Mac.
- Applicants need to complete a comprehensive mortgage application, providing various documents, their credit history, and current credit score.
- The interest rates for conventional loans are often higher compared to FHA loans.
Understanding Conventional Mortgages
Conventional mortgages have fixed or variable interest rates and are not federally guaranteed, leading to stricter lending criteria.
Organizations like the Federal Housing Administration, the U.S. Department of Veterans Affairs (VA), and the U.S. Department of Agriculture (USDA) offer alternatives, though these come with unique qualification requirements. For instance, FHA loans are known for their lower down payments and no closing costs.
In May 2023, changes were made to the upfront fees of Fannie Mae and Freddie Mac. Homebuyers with higher credit scores observed increased fees, while those with lower scores saw decreased fees.
Example of a Conventional Mortgage Scenario
Consider a scenario where you purchase a home valued at $500,000 with a $100,000 down payment (20%) and have a good credit score of 650. You might secure a conventional mortgage with a locked-in rate of 5.50%, resulting in monthly payments of around $2,271 over a 30-year loan for the principal and interest.
Conventional Mortgage vs. FHA Mortgage
The main distinction is that FHA loans ease homeownership for low- to moderate-income buyers who struggle with traditional financing. FHA loans require lower down payments, have flexible credit requirements, and are provided by FHA-approved lenders. In contrast, conventional loans necessitate excellent credit scores with firmer lending criteria and higher interest rates.
Conventional vs. Conforming Mortgages
While conventional loans are often mistaken for conforming mortgages, not all conventional loans qualify as conforming. A conforming loan must meet the standards set by Fannie Mae and Freddie Mac, primarily a dollar limit set by the Federal Housing Finance Agency.
For example, jumbo mortgages exceed the conforming limit and thus operate as conventional mortgages but not as conforming ones.
Types of Conventional Mortgages
- Conforming conventional loans: Adhering to Fannie Mae and Freddie Mac’s standards.
- Jumbo loans: Exceeding the maximum lending limit with higher requirements.
- Portfolio loans: Kept within the lender’s portfolio rather than being sold.
- Subprime loans: Offered to borrowers with lower credit standings.
- Amortized conventional loans: Feature a set monthly payment over the loan period.
- Adjustable-rate loans: Begin with a fixed rate then adjust annually.
Essential Documentation for a Conventional Mortgage
1. Proof of Income:
- 30 days’ pay stubs with year-to-date income
- Two years’ federal tax returns
- Asset account statements covering 60 days to a quarter
- Two years of W-2 statements
2. Assets:
Bank and investment account statements for down payment and closing costs; gift letters if applicable.
3. Employment Verification:
Lenders expect pay stubs and additional paperwork for self-employed individuals.
4. Other Documentation:
Duplicate of your ID, Social Security number, and authorization for credit check.
Understanding Interest Rates on Conventional Mortgages
Interest rates depend on loan terms, the loan amount, whether rates are fixed or adjustable, and the economic context. Points—or fees paid to lenders—affect your interest rates, generally decreasing with more points paid. Individual financial profiles also play a significant role.
Special Considerations for a Conventional Mortgage
Eligible Candidates:
- A credit score of at least 620.
- Sufficient debt-to-income (DTI) ratio around 36-43%.
- A 20% down payment for better terms.
Ineligible Candidates:
- Recent bankruptcies or foreclosures.
- Credit scores below 620.
- DTI ratios exceeding 43%.
- Insufficient down payment funds.
First-time homebuyers or those lacking credit history may find FHA loans more accessible.
Comparing FHA Loan and Conventional Loan
FHA loans target low-income borrowers with less stringent credit criteria, whereas conventional loans require better credit and often have higher interest rates.
Final Thoughts
A conventional mortgage is an invaluable tool for homebuyers who meet the stricter lending criteria, providing various advantages over FHA and other government-backed loans.
Related Terms: Fannie Mae, Freddie Mac, Federal Housing Administration, credit score, down payment.
References
- The Mortgage Reports. “Are conventional loan rates higher than other mortgages?”
- Consumer Financial Protection Bureau. “Conventional Loans”.
- U.S. Department of Housing and Urban Development. “Let FHA Loans Help You”.
- U.S. Department of Veterans Affairs, Veterans Benefits Administration. “VA Home Loans”.
- U.S. Department of Agriculture, Rural Development. “Single Family Housing Programs”.
- Fannie Mae. “Loan-Level Price Adjustment Matrix”. Page 2
- Federal Housing Finance Agency. “FHFA Announces Conforming Loan Limit Values for 2024”.
- U.S. Department of Housing and Urban Development. “Fact Sheet: FHA’s Impact in 2023 – Making Homeownership Possible for Hundreds of Thousands of Families.”
- Federal Reserve History. “Subprime Mortgage Crisis”.
- Consumer Financial Protection Bureau. “Debt-to-Income Calculator”, Page 3.
- U.S. Department of Housing and Urban Development. “Single Family Upfront Mortgage Insurance Premium (MIP)”.
- Consumer Financial Protection Bureau. “What Are (Discount) Points and Lender Credits and How Do They Work?”
- myFICO. “What Credit Score Do You Need to Buy a House?”
- Consumer Financial Protection Bureau. “Debt-to-Income Calculator”, Pages 1–2.
