Loans from private lenders that aren't insured by the government have strict requirements. But they can give homebuyers who qualify better rates and lower mortgage payments.
Conventional loan, or private mortgage, is not insured or backed by the government
Two types of conventional loans are conforming mortgages and nonconforming mortgages
The conforming loan limit for single-family property mortgages in 2020 is $510,400 and up to $765,600 in some high-cost areas
It’s better for homebuyers to get a conventional mortgage over an FHA loan when they’re in good financial standing because they qualify for the best (lowest) rates
When you buy a house, you’ll be faced with a lot of different mortgage questions and choices — a fixed-rate mortgage or an adjustable-rate mortgage, a 15-year or 30-year mortgage term, just to name a few. But before you consider these loan options, you need to decide what type of financing you want.
There are two main types of financing when it comes to mortgages: Loans that are backed by the government and loans that are not, which are called conventional loans. Mortgages backed by government agencies like the Department of Housing and Urban Development (HUD) have less restrictive requirements to help more people qualify for a loan to buy a house.
Conventional mortgages can be further divided into conforming loans and nonconforming loan types, depending on if the loan follows certain federal regulatory standards. If this sounds confusing, don't worry. We’ll explain what a conventional mortgage is and how it compares government-backed mortgages like FHA loans.
A conventional loan is any mortgage loan that is not insured or backed by the government. You can get a conventional loan from a bank or credit union or even an online lender. A conventional loan is sometimes called a private mortgage.
About 69% of people who bought a house in 2019 took out a conventional loan, making it the most popular type of mortgage.
Conventional loan requirements have more strict financial requirements than those for government-insured mortgages. Getting the best rates depends largely on your credit score and your debt-to-income ratio. While mortgage rates can fluctuate based on economic factors, you’ll have a much better chance of getting low rates when you have an excellent credit score and a low debt-to-income ratio.
(Looking to buy a house or refinance, check out today’s mortgage rates, updated weekly.)
With most conventional mortgages, the lender will require you to get mortgage insurance PMI if you don’t make a down payment of at least 20%. A larger down payment can reduce your loan-to-value ratio, which may get you an even lower interest rate.
(The first step to getting a mortgage is getting mortgage preapproval.
When you’re buying a home, you might hear the term loan limits, or restrictions on the size of the loan. Conventional loans have limits if they are conforming loans. For example, if the size of the mortgage exceeds the conforming loan limits, it can still be a conventional loan, just not a conforming one.
Conforming loan limits are $510,400 for single-family properties in most counties and $765,600 in a few high-cost counties. The limits are based on median housing prices and updated annually.
Conforming loans and nonconforming loans are two different types of conventional loans, which we’ll talk about next.
Conforming mortgages follow requirements set by Fannie Mae and Freddie Mac, two government-sponsored enterprises that guarantee loans to reduce risk to investors. Mortgages that don’t follow these standards, including those that exceed the loan limit mentioned above, are considered nonconforming.
Just because a mortgage loan doesn’t adhere to Fannie and Freddie’s criteria does not mean it is substandard or shoddy. Some loans are nonconforming because of their size. Called jumbo loans these mortgages are common in commercial real estate transactions and may be the only way to get financing if you’re buying that million-dollar mansion (just make sure you can afford it — use a mortgage calculator to see what your monthly payment could look like).
Other mortgages may be nonconforming because the type of property doesn’t meet certain standards, for example if you’re buying a condo, in order to get a conforming loan at least half the units in the building must be owner occupied. The loan may also become nonconforming because it’s extended to someone who doesn’t have good financials. For example, there are mortgage underwriting standards that require the borrower to meet a certain debt-to-income ratio and credit score for the borrower. This can help people in unique circumstances, like a medical student who will likely become a high earner in the future
However, nonconforming loans may have risky terms and repayment plans (most subprime loans fall into this category). You should make sure you thoroughly understand the mortgage terms set by your lender for any loan you take out.
If you can’t qualify for a conventional mortgage loan, then you can try getting a mortgage insured by the Federal Housing Administration. FHA loans (and other government-insured mortgages like VA loans and USDA loans) can be advantageous to less financially qualified homebuyers since these loan programs have more lenient requirements. You won’t need to have as high of an income or credit score to qualify, and you may not need to make a large down payment.
FHA loans rates are slightly higher than the average conventional loan rates for homebuyers in good financial standing. That means people with higher credit scores and lower debt-to-income ratios who meet conventional loan requirements stand to benefit more from a private mortgage than an FHA loan. They can qualify for lower rate and monthly payment.
Keep in mind that FHA loans can also require the borrower to pay a mortgage insurance premium (MIP) in addition to the monthly mortgage payment over the entire lifetime of the loan which can make it more costly in total than a conventional mortgage. To get rid of the insurance payment, you would have to refinance to a conventional home loan and have at least 20% equity.
Learn everything you wanted to know about conventional loans vs FHA loans here.
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Elissa is a personal finance editor at Policygenius in New York City. She writes about estate planning, mortgages, and occasionally health insurance. In the past she has written about film and music.
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