Which Loan Fits Your Needs? Types of Conventional Loans: An Overview

The right mortgage is a crucial piece of your homebuying puzzle.

But with all the loan types available, how do you choose the right one for your needs?

Here we’ll break down four common types of conventional loans and help you figure out which one is best for your situation—whether you’re buying or refinancing.

4 conventional loan types

Conventional loans are any mortgages offered by private lenders. These include banks, credit unions, or mortgage companies. Conventional mortgages differ from loans offered or secured by a government entity, such as the FHA, USDA, or VA.

Conventional loans come in all shapes and sizes, so they are a popular mortgage choice for home purchases and refinances. Here are several options you should know about.

Conforming loans

Most conventional loans are also conforming loans. Conforming describes a mortgage that conforms to requirements set by the Federal Housing Finance Agency (FHFA). The FHFA is the government organization that oversees and regulates certain mortgage guidelines and entities. It exists to protect borrowers, lenders, and the secondary market where mortgage backed securities (MBS) are traded.

As long as a loan meets the FHFA guidelines, it can be sold to Fannie Mae or Freddie Mac—two government-sponsored enterprises (private corporations chartered by Congress) that purchase mortgages. Why does this matter? Because most lenders sell your loan to mortgage investors (like Fannie and Freddie) after closing to free up cash so they can continue providing more loans to more borrowers.

This removes the loan from the lender’s portfolio, allowing them to offer more favorable interest rates and lend to more borrowers.

Conforming mortgage requirements may vary slightly by lender, but typically you’ll need a credit score of 620 or higher and a down payment of at least 3%. You’ll also need to demonstrate that you have a consistent income and limited debt compared to your income.

Non-conforming loans

Non-conforming loans do not meet FHFA standards, so they are not sold to Fannie Mae, Freddie Mac, or investors who only want FHFA-approved loans. Therefore, these mortgages can be riskier because they are more difficult to sell. For this reason, not all lenders offer non-conforming loans.

One non-conforming loan commonly offered by private lenders, including Better Mortgage, is known as a jumbo loan. As the name implies, these mortgages are often much larger, and intended for people who borrow a loan amount higher than the conforming loan limits set by the FHFA. To qualify for a jumbo loan, you’ll typically need at least 10% down and a credit score of 700.

Portfolio loans

A portfolio loan is a type of mortgage that a lender intends to keep instead of selling on the secondary mortgage market. Because a portfolio loan is kept within a lender’s portfolio, they set all qualification guidelines, which may make it easier for some borrowers to get approved.

However, in exchange for less strict requirements, portfolio loans generally come with higher mortgage interest rates and origination fees. They may also have less flexibility and prepayment penalties, so make sure you understand your obligations before applying.

Not all lenders offer portfolio loans, so you’ll need to do your research if you’re interested in this option for home financing.

Non-qualified loans

A non-qualified mortgage, or non-QM loan, is a mortgage that does not meet certain lender protection and secondary market trading requirements set by the Consumer Financial Protection Bureau (CFPB). This means they often come with looser credit and financial conditions, making them a good potential option for some self-employed borrowers, rental property investors, or anyone who doesn’t meet the more stringent standards of other mortgage loans.

Non-QM mortgages aren’t eligible for purchase by Fannie Mae or Freddie Mac and cannot be backed by a government-sponsored entity, such as the FHA or USDA. As a result, they are riskier for lenders and typically come with higher interest rates.

Fixed-rate vs. adjustable rate terms for your conventional loan

Your loan options don’t just stop and end at the loan types above. Most conventional loans can also be broken down by how the interest rate is applied and your loan terms. Conforming, non-conforming, portfolio, and non-qualified loans may be available with fixed or adjustable rates. Here are the differences:

Fixed-rate

Loans with a fixed rate have the same interest rate for the entire life of the loan. Fixed-rate mortgage terms can be 10, 15, 20, or even 30 years. The longer the term of the mortgage, the more affordable the payments, but you’ll also pay more interest over time and take longer to own your home outright.

Fixed-rate mortgages may be appealing because of their predictability. They can make it easier to budget because your mortgage’s principal and interest will never change. Having a fixed interest rate can be especially beneficial if you plan to stay in your home long term. If interest rates rise in the future, you won’t have to worry about your interest costs and monthly payments increasing.

Adjustable-rate

An adjustable-rate mortgage, commonly known as an ARM, features an interest rate that adjusts according to market fluctuations. Typically, the mortgage rate is fixed for the first few years, and it may increase or decrease thereafter. For example, a 5-year ARM or “5/1 ARM” has a fixed interest rate for the first 5 years, but the rate will vary once per year for the remaining 25 years of the loan. Other popular ARM terms are 10/1 ARMs (fixed rate for the first 10 years, then annual adjustments) or 5/6 ARMs (fixed rate for the first 5 years, then rate adjustments every 6 months).

The advertised interest rates of ARMs may be hard to resist, as they are typically less than those for fixed-rate mortgages. For this reason, ARMs may be a good option if you think you’ll move or refinance before the fixed-rate portion of your loan ends.

Otherwise, an adjustable-rate mortgage could be risky. If mortgage rates rise after the fixed term is up, then your payments may increase, too. But, on the bright side, if rates decrease, you could reap the benefits of lower rates without having to refinance.

Understanding conventional loan down payments

Conventional loan requirements

Understanding conventional loan requirements is crucial when you're considering a mortgage for a home purchase or refinance. They're offered by banks, credit unions, and direct lenders—such as Better Mortgage—and they're far and away the most common kind of mortgage you're likely to encounter. In most cases, including at Better Mortgage, conventional loans require a credit score of 620 or higher. ]Debt-to-income ratio](https://better.com/content/what-is-a-good-debt-to-income-ratio) maximums also vary by lender and typically range from 36 to 50%.

Minimum down payment requirements

Conventional loans are favored by many due to their flexibility in down payment requirements. For first-time homebuyers, the minimum down payment for a conventional loan can be as low as 3%. This allows buyers to enter the housing market sooner without waiting years to accumulate a larger down payment. However, it's important to note that with a down payment of less than 20%, lenders typically require private mortgage insurance (PMI), which will add to the monthly mortgage payment until the homeowner's equity reaches at least 20%.

Benefits of larger down payments

While the minimum down payment starts at 3% for qualifying first-time buyers, there are significant benefits to making a larger down payment if possible. For instance, a 5% down payment opens up the possibility of qualifying for an adjustable-rate mortgage (ARM), which can be particularly advantageous for those planning to sell their home within a decade. The initial period of an ARM offers a lower interest rate, which can significantly reduce the cost of borrowing during those years.

For those who are not first-time homebuyers or who are purchasing in high-cost areas, a down payment of 10% might be more appropriate. This higher down payment reduces the loan amount, thereby decreasing monthly payments and the total interest paid over the life of the loan. Additionally, for very high-cost areas, a down payment of just over 10% may allow buyers to qualify for jumbo loans, which are necessary for loan amounts exceeding the limits set by the Federal Housing Finance Agency (FHFA).

There are plenty of loans in the sea

Conventional mortgages can provide a variety of options for your home purchase or refinance needs. If you’re ready to take the next step, then it’s time to get pre-approved. Getting a mortgage pre-approval offers a lot of benefits. It can help you understand how much house you can afford and show sellers you’re serious about buying their home—which can be especially helpful in competitive markets.

Applying for a conventional loan with Better Mortgage

The first step to apply for a loan with Better Mortgage doesn’t require any documentation. You’ll simply need to complete a pre-approval, which can be done in as little as 3 minutes by answering some questions about your financial situation. Start today to find the best loan option for your needs.