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- A conventional mortgage isn’t backed by the government and has stricter eligibility requirements.
- Conforming loans meet the FHFA borrowing limit, and nonconforming loans exceed the borrowing limit.
- You may qualify for a conventional mortgage if you have a good credit score, among other factors.
What is a conventional mortgage?
One of the first decisions you’ll make when shopping for a home loan is whether you want a government-backed loan or a conventional loan.
A government-backed loan is backed by a federal agency such as the Federal Housing Administration, United States Department of Agriculture, or Veterans Affairs. If you select a mortgage that’s backed by the government, the agency pays the lender on your behalf. When a lender gives you a government-guaranteed mortgage, it’s like the lender is getting insurance on your loan.
A conventional loan is not guaranteed by the government. A private lender, such as a bank or credit union, gives you the loan without insurance from the government. But you may choose a conventional mortgage backed by government-sponsored mortgage companies Fannie Mae or Freddie Mac.
A conventional loan usually has stricter eligibility requirements than a government-backed loan. You’ll need a higher credit score, lower debt-to-income ratio, and more money for a down payment.
Government-backed loans may have their own eligibility requirements. For example, a VA loan is only for people who have served in the armed forces.
Types of conventional mortgages
Conventional mortgages can be broken down into two categories: conforming and nonconforming loans. The main difference between these two types is the amount of money you need to borrow.
A conforming mortgage meets the standards set by the Federal Housing Finance Agency (FHFA). The FHFA sets the limit for conforming loans every year. In 2023, the limit is $726,200 in most parts of the US. In areas with a higher cost of living, the limit goes up to a max of $1,089,300.
A nonconforming mortgage is for an amount that exceeds the FHFA limit. You also might hear it referred to as a jumbo loan.
To qualify for a nonconforming mortgage, you’ll likely need a higher credit score, bigger down payment, and lower debt-to-income ratio than you would for a conforming loan.
If you need more money than allowed by the FHFA or qualify for the loan, a nonconforming mortgage may be for you. If not, you’ll want to go with a conforming mortgage.
Who qualifies for a conventional mortgage?
For the most part, the eligibility requirements for a conventional mortgage break down into three categories: credit score, debt-to-income ratio, and down payment.
If you can’t meet all three qualifications, you’ll want to check if you qualify for a government-backed mortgage or wait to buy a home. With more time, can improve your credit score, pay off some debt, or save more for a down payment.
Credit score
You’ll typically need a credit score of at least 620 to qualify for a conforming loan. For a nonconforming loan, you’ll probably need a score of 700 or higher.
Debt-to-income ratio
Your debt-to-income ratio is the monthly amount you pay toward debts divided by your gross monthly income. For example, if you spend $2,000 per month on your mortgage and student loan payments, and you earn $3,000 per month, your DTI ratio is $2,000 divided by $3,000, or 66%.
You might qualify for a mortgage with a DTI ratio as high as 43%, depending on the lender. Most lenders like to see a DTI ratio of 36% or less, though.
Many lenders require lower DTI ratios for nonconforming mortgages than for conforming mortgages. A lower ratio means you owe significantly less than you earn, leading lenders to believe you can afford the high payments that accompany a jumbo loan.
Down payment
As a general rule of thumb, many lenders accept down payments of 10% or less for conforming loans but require at least 20% upfront for a nonconforming loan.
If you know you don’t have that large of a down payment ready, don’t throw in the towel. You can request your loan be backed by Freddie Mac or Fannie Mae, and you’ll only need a 3% down payment.
Each lender has different down payment requirements for a jumbo loan. For example, Ally typically accepts as low as 20% down for a nonconforming loan.
Conventional mortgage interest rates
Conventional mortgage rates are usually a little higher than government-backed rates. But government loans come with fees that could end up costing you more than the higher rate would. If you’re trying to decide between a conventional or government-backed mortgage, do the math instead of assuming the lower rate is the better option.
Here are the factors that affect your conventional loan interest rate:
Economy
Rates typically decrease in response to a struggling economy, because low rates encourage people to borrow and can stimulate the US economy.
When the economy is thriving, there’s usually a higher demand for borrowing. Rates go up, as a result, to slow down the influx of applications.
Where you live
You may have noticed that houses are more expensive in cities than in rural areas, or more expensive in certain cities and states than others. But where you live affects your interest rate, too. Interest rates are usually higher in areas with a higher cost of living, but the difference shouldn’t be huge.
Personal finances
Your credit score, debt-to-income ratio, and down payment don’t just determine whether you’ll qualify for a conventional mortgage — they also help determine your interest rate.
The higher your credit score, the lower your rate. You could get a great rate with a score of 760 or higher. To increase your score, try to pay off debts, make all your monthly payments on time, and use a low percentage of your available credit.
You can get a better rate with a lower debt-to-income ratio. The two main ways to lower your ratio are by paying down debts and earning more.
The more you have for a down payment, the lower your rate could be. If you don’t have much saved for a down payment, consider taking the time to accumulate more before you buy.
Term
You’ll need to choose between a fixed-rate or adjustable-rate mortgage.
A fixed-rate mortgage locks in your rate for the entire life of your loan. Although US mortgage rates will increase or decrease over the years, you’ll still pay the same interest rate in 30 years as you did on your very first mortgage payment.
An adjustable-rate mortgage, or ARM, keeps your rate the same for the first few years, then periodically changes over time — typically once a year.
Right now, adjustable rates are starting lower than fixed rates. An ARM may be a worthwhile option if you’re not buying a forever home, because you could move before risking a rate increase.
Term length
You’ll also choose a term length, or how many years you’ll spend paying back the loan.
For fixed-rate mortgages, a 30-year term is the most common option. Most lenders also offer 15-year and 20-year loans. Some have even more term lengths to choose from.
A 5/1 ARM is the most common type of adjustable-rate mortgage. You’ll pay the same rate for the first five years, then your rate will change once per year. Most lenders also have 7/1 and 10/1 ARMs.
The longer your term, the higher your rate will be.
Points
At closing, you can choose to pay a fee to receive mortgage points. The more points you have, the lower your rate will be.
One mortgage point is typically 1% of your mortgage. If your loan is $100,000, one point would cost you $1,000.
One point will usually drop your rate by 0.25%.
For example, you buy a home with a $100,000 mortgage at a 3.5% interest rate. You pay $2,000 at closing for two mortgage points, so your rate drops by 0.5% total. You’ll now only pay 3% on your loan.