What is a conventional mortgage?

Conventional home loan types

A conventional loan can be either conforming or nonconforming, depending on whether it meets Federal Housing Finance Agency (FHFA), Fannie Mae and Freddie Mac requirements.

Here is what you need to know about the different types of conventional home loans.

• Conforming: These must meet FHFA, Fannie Mae and Freddie Mac requirements. Each year, the maximum loan limit changes based on the housing market and the area. Some states, like Hawaii and Alaska, have higher limits. Conforming loans are the most popular mortgage type.
• Nonconforming: These loans do not meet the requirements to be acquired by Fannie Mae or Freddie Mac. It is common for investment properties or second homes to be nonconforming loans.
• Jumbo:Jumbo loans are a type of nonconforming loan for higher-priced homes that exceed the maximum loan limit. To be eligible for a jumbo loan, you need good credit and a large down payment.

Fixed-rate vs. adjustable-rate mortgages

ARMs typically come with a lower interest rate that is fixed for three to five years before the loan’s rate fluctuates.

Whichever loan type you go with, you may have the option between a fixed-rate loan and an adjustable-rate mortgage (ARM). With a fixed rate, your interest rate stays the same for the duration of the loan, which means your monthly payments remain the same. Typically, fixed-rate loans come in 15- or 30-year terms, but some lenders might offer other options.

ARMs, on the other hand, have a fixed rate for a specific time and then an interest rate that can fluctuate over time based on market conditions. This means your monthly payment can go up or down. For example, if you choose a 5/1 ARM, for the first five years you will have a fixed interest rate, and then your interest rate will be adjusted each year afterward.

» MORE: How much house can I afford?

Conventional mortgage requirements

Requirements differ slightly by lender for conventional mortgages. However, most conventional mortgage lenders have these eligibility standards:

• Credit score: You want a credit score of at least 620 — or 680-plus for jumbo loans.
• Debt-to-income (DTI) ratio: Your DTI ratio should be at 50% or lower.
• Down payment: These loans require at least 3% down, although this can vary by the lender, your profile as an applicant and the loan type. Putting down 20% helps you avoid private mortgage insurance (PMI).
• Proof of income: You should have at least two years of documentation proving stable income (e.g., tax returns, W-2s, pay stubs, bank statements).
• Loan amount: The amount of a conventional loan can’t exceed the maximum conforming loan limit, which is set each year by the FHFA.

» MORE: What credit score is needed to buy a house?

What’s the difference between conventional loans and government-backed loans?

Overall, government-backed loans are less risky for lenders than conventional mortgages because the government guarantees them. As a result, borrowers may have an easier time qualifying. They tend to have lower requirements for credit score, DTI ratio and down payments.

Government-backed mortgages are designed for specific purposes, and they don’t fit every borrower. Let’s see how a conventional mortgage compares with different types of government-backed mortgages.

Pros and cons of conventional loans

In general, conventional mortgages have fewer restrictions than government-backed loans — even if some of the requirements are stricter for borrowers. Lenders have more flexibility with conventional loans because they set their own eligibility standards.

“If you have a robust credit score and can afford a solid down payment, a traditional mortgage offers more flexibility and potentially lower costs over time,” said Gagan Saini, director of acquisitions at JiT Home Buyers in Metairie, Louisiana.

Consider these advantages and disadvantages of conventional mortgage loans before making your choice.

» MORE: How to buy a house

Bottom line

A conventional mortgage is the most common type of mortgage in the industry and offers flexibility with loan amounts, down payments, term lengths and interest rates. If you have good credit, low debt and a healthy income, a conventional mortgage is often a good choice.