Conventional Loans: Requirements, Types And Rates

What Is A Conventional Loan?

A conventional mortgage is any home loan not insured by a federal government agency such as the U.S. Department of Veterans Affairs, U.S. Department of Agriculture or Federal Housing Administration. These loans are originated and serviced by private mortgage lenders, a group that includes credit unions, banks and other financial institutions.

If you are applying for a loan that isn’t insured by a federal agency, you’re probably applying for a conventional mortgage.

Conventional mortgage loans can be divided into two basic categories: conforming and nonconforming.

If a loan can be purchased by Fannie Mae or Freddie Mac, it is a conforming loan. Otherwise, it’s a nonconforming loan. Conforming loans must follow certain guidelines that the entire mortgage industry is subject to, while the guidelines for nonconforming loans are decided by individual lenders.

Conforming Conventional Loans

It can take homeowners a long time to pay off their mortgages. One of the most common types of loans, after all, is the 30-year, fixed-rate mortgage. As the name suggests, homeowners who hold this mortgage type for its full term will take three decades to pay it off.

Mortgage lenders typically don’t want to wait three decades– or 15 or 10 years for shorter-term loans – to get back the money, with interest, that they lend to homeowners. Lenders need a more consistent cash flow if they want to continue lending money to home buyers.

To help provide that cash flow, lenders often sell their mortgage loans to investors. These investors might keep a small number of mortgages in their portfolio while selling the rest on the bond market. These sales from lenders to investors keep the cash flowing to mortgage lenders.

The largest buyers of conventional mortgages are Fannie Mae and Freddie Mac, both of which are government-sponsored enterprises. While both Fannie and Freddie operate independently of the federal government, the agencies must follow certain rules to ensure that they operate in a responsible way. The federal Housing Finance Agency, or FHA, is the government agency that oversees Fannie and Freddie.

Fannie and Freddie have standards for the types of mortgages they’ll buy. Their goal is to make sure that the mortgage market is filled with creditworthy mortgages. If a mortgage fits within their standards and is eligible to be bought by Fannie Mae or Freddie Mac, it’s considered to be a conforming loan.

A conforming mortgage loan must also meet certain size limits imposed each year by the Federal Housing Finance Agency. For 2022, mortgages for most one-unit homes across the United States can be as high as $647,200 and still be considered conforming. Mortgages over this amount will be considered jumbo loans and are no longer categorized as conforming loans.

Jumbo loans typically come with higher interest rates and require larger down payments. Borrowers will typically need higher credit scores.

In certain higher-cost areas of the United States, including cities such as New York City, Los Angeles and San Francisco, the conforming loan limit is even higher. For 2022, mortgages for one-unit homes in these high-cost areas can be as high as $970,800 before they are considered nonconforming jumbo mortgages.

Nonconforming Loans

The big difference between conforming and nonconforming conventional loans is that lenders can’t sell nonconforming mortgage loans to Fannie Mae or Freddie Mac, reducing the selling opportunities for these loans. Lenders can sell nonconforming mortgage loans to private investors.

The most common type of nonconforming loan is a jumbo loan. If you want to finance the purchase of a home with a mortgage that is higher than your area’s conventional loan limits, you must apply for a nonconforming loan.

The requirements borrowers must meet for nonconforming loans will vary by individual lender. In general, though, borrowers will need both higher down payments and credit scores to qualify for a nonconforming loan. These loans usually come with higher interest rates, too.

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