Understanding Conventional Mortgages

Conventional mortgages are the plain vanilla of home loans. These loans — in particular, the 30-year fixed-rate conventional mortgage with a substantial down payment — are what most people think of when they think about borrowing to purchase a home.

In mortgage-speak, loans break down into two categories — conventional and government. A conventional mortgage is the industry phrase for a loan made by a private lender, such as a bank. Many conventional loans are subsequently sold to Fannie Mae or Freddie Mac, the quasi-governmental companies that exist to buy up great quantities of loans to keep money circulating through the loan system. In contrast, government loans are backed by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA) or the U.S. Department of Agriculture (USDA).

In this section, you’ll find more information about conventional loans, including the different loan categories, how to qualify and how mortgage insurance works. In addition, you can browse for the loan limits in your area for conventional loans that meet Fannie Mae and Freddie Mac guidelines.

Types of Conventional Loans

Conventional loans fall into three categories:

Conventional loans offer a dizzying variety of options. The 30-year fixed-rate loan is the default choice. If you prefer to pay off the mortgage more quickly, you can choose a 10-, 15- or 20-year fixed-rate loan. Shorter-term fixed-rate loans offer lower interest rates but higher monthly payments. You can also get an adjustable-rate conventional loan, which starts at a lower rate for a fixed period of years before adjusting to prevailing market rates in the future.

Advantages of Conventional Loans

There’s a mortgage for nearly every homebuyer. Most are variations on the standard conventional mortgage. It can be worthwhile to streamline your application to fit the typical mold.

No Up-Front Mortgage Insurance

With a conventional loan, you can avoid paying mortgage insurance so long as you make a 20 percent down payment. Or, if you put down less than 20 percent, you can remove the mortgage insurance cost after you’ve built equity in your home.

No Lifetime Mortgage Insurance

FHA and USDA loans require insurance for the life of the loan. Government loans require insurance premiums regardless of the amount of the down payment. Stick with a conventional loan if you can afford a 20 percent down payment and have a good credit history.

No Government Bureaucracy

Approval of FHA, VA, and USDA loans can be delayed by government bureaucracy. Government lenders require more documentation, which takes time to prepare.

7 Steps to Qualify for a Fannie or Freddie Loan

Keep the following seven factors in mind when you consider a conventional mortgage. Take these steps if you want to qualify for a great interest rate and the lowest fees on a conventional mortgage:

1. Boost Your Credit Score

If you’re hoping for a government-sponsored enterprise (GSE) loan, it helps to have good credit. In 2014, about 60 percent of Fannie and Freddie borrowers had FICO scores of 740 or higher, according to the Federal Housing Finance Agency (FHFA). About 40 percent of borrowers had credit scores from 620 to 739, up significantly from 2010. And only 1 percent had FICO scores of less than 620.

2. Clean-Up Your Credit History

Your FICO score is one of the magic numbers for loan approval. Because your credit history directly affects your credit score, you should scrutinize your credit reports issued by Experian, Equifax and TransUnion, the three main credit reporting agencies. Meanwhile, Fannie and Freddie look askance at some blemishes in your credit history, such as selling a house for less than what was owed on the mortgage.

3. Save for a Down Payment

The more you put down, the more you stand to lose if you decide not to pay your mortgage. That is the rationale behind the currently high down payment requirements demanded by Fannie and Freddie. To get the best rate, you’ll need 40 percent down. In 2011, the average down payment for Fannie and Freddie loans was 20 percent. By 2014, that amount had ballooned to 35 percent, according to the FHFA.

4. Cut Your Debt-to-Income Ratio

If Fannie and Freddie are playing tough with down payments, but they’re even stricter taskmasters when it comes to debt-to-income (DTI) ratios. Lenders say that GSEs are sticking to a 43 percent cap on debt-to-income ratio. In other words, if your monthly income is $5,000 a month, your total debt load (including mortgage, car loans and student loans) would have to be no more than $2,150 to qualify for a mortgage. There are exceptions to the 43 percent DTI rule, described below. The logic behind high DTI ratios is rooted in lenders’ experience during the financial crisis. Many borrowers who made tiny down payments kept paying off their loans through the downturn. But borrowers whose income was overwhelmed by debt couldn’t pay even if they wanted to.

5. Document Your Assets

Depending on the amount of your down payment and your credit score, you might be required to prove you have enough cash on hand and short-term investments to cover several months’ worth of mortgage payments. Fannie Mae requires borrowers who are buying a home but who haven’t sold their previous home to hold enough in reserves to cover six months of payments on both loans.

6. Prove Your Employment or Income

If you want a GSE loan, you’ll need to document your income and employment history. The more stable your income, the better, at least in the eyes of Fannie and Freddie. In general, it’s easier to qualify if you collect a regular paycheck from an employer. A W-2 and a few recent paychecks will meet the proof-of-income requirements. If you’re self-employed, expect scrutiny from an underwriter who wants to make sure your business income is stable and consistent.

7. Consider Avoiding Mortgage Insurance

Private mortgage insurance (PMI) protects the lender if you stop making payments on your loan. Lenders typically require you to buy PMI if your down payment is less than 20 percent of the price of the home. PMI premiums are added to your monthly mortgage payment.

Shopping for a Lender

There are three key factors in a good mortgage deal. The interest rate, of course, is the biggest item you should look at when you compare proposals. But it’s not the only factor to consider. Look closely at the closing costs each lender offers you. And finally, weigh the customer service provided by the loan officer and his or her assistants.

Good customer service involves more than returning your calls, though that’s a good indicator. Your closing will be affected by how quickly and efficiently the lender processes paperwork and coordinates with other service providers.

5 Tips for Finding a Lender

  • If you’re working with a real estate agent, ask for a recommendation — your agent only gets paid if you get a loan and close on the house, so the agent is motivated to refer you to an effective loan officer.

  • Ask friends and coworkers for suggestions.

  • Contact your bank or credit union and ask about a home loan offerings.

  • Read business review and evaluation websites such as JD Power.

  • As you gather referrals and research, ask if the recommenders receive a referral fee for passing your name along. This will help you understand all the factors that shaped the recommendation.

There’s a good chance the originating lender won’t be the “servicer” that collects your payments for the duration of the loan. If you’re concerned about someone else servicing your loan, ask your loan officer to explain the company’s policy. Seek a portfolio lender if you want your lender to be your servicer for the life of the loan.

How Lender Quotes Affect Your Credit

Some websites will take some basic information about you and the home you want to finance, then send that information to multiple loan officers who will call you to learn more about your situation to give you a ballpark figure on your loan costs and interest rate. Some of these sites will do a soft pull on your credit reports, which will appear in your credit history. These soft pulls have no impact on your credit score. However, once a loan officer gets you on the phone, they may do a hard pull on your credit history, which will result in a slight, temporary ding to your credit score. The good news is the FICO scoring software sees multiple home loan-related hard pulls in a short period as one hard pull. You can minimize harm to your credit score by clustering your home loan shopping over a two-week period.

How Private Mortgage Insurance Works in Conventional Loans

Borrowers pay for private mortgage insurance (PMI). If something happens and the homeowner defaults — allows a foreclosure — the insurance company pays the lender, and not the borrower.

Conventional lenders typically require you to buy PMI if your down payment is less than 20 percent of the price of the home. PMI is offered by a separate company that has its own underwriting guidelines, and premiums are added to your monthly mortgage payment. You might be able to cancel private mortgage insurance after a few years if you pay down your loan balance to a certain amount, says the Consumer Financial Protection Bureau (CFPB). It’s up to you to track this and request that the PMI be dropped once your equity crosses 20 percent. That might happen by steadily paying off the loan, or if the property appreciates, increasing your equity.

Government loans require borrowers to keep paying mortgage insurance premiums for the life of the loan, even after the borrower has built enough equity that the loan poses almost no risk of default. That’s why first-time buyers or cash-strapped borrowers often will use an FHA loan to buy a house, and then later refinance into a conventional loan after they’ve built equity.

The key equation to remember is: the riskier your loan, the higher your PMI premium.

A Tale of Three Mortgages: The Cost of PMI

A person with a high FICO score wants to buy a $200,000 home. How much can she save with a large down payment?

Percent Down Amount Down Monthly Mortgage Insurance Cost
20% $40,000 $0
10% $20,000 $64.50
3% $6,000 $179.45

The amount of the down payment isn’t the only factor affecting PMI costs. A lower FICO score also boosts your premium. To see how much PMI might cost you, put your numbers into the PMI calculator below.

Private Mortgage Insurance Calculator

Private mortgage insurance protects conventional mortgage lenders, making homeownership possible for buyers with smaller down payments. Learn how much PMI might cost you and ways to avoid paying for it.


3 Myths About Conventional Loans

Myth #1: You Need a 20 Percent Down Payment

It used to be the rule, but these days, you might have to put down 40 percent to win the best rates, says Brett Sinnott, vice president of capital markets at CMG Financial. Fannie Mae and Freddie Mac have unveiled loan programs that let borrowers put down as little as 3 percent. Fannie Mae’s program is primarily for first-time buyers, while Freddie Mac’s offer is for borrowers with modest incomes.

Myth #2: You Need a Debt-To-Income Ratio of Less Than 43 Percent

It helps, but it’s not a must. The CFPB issued a rule that allows small lenders to make loans to borrowers with high debt ratios. The CFPB also lets large lenders make loans to high-debt borrowers, so long as the lender makes a reasonable, good-faith effort to determine borrowers can repay the loan. However, Brett Sinnott says, lenders prefer not to budge on DTI. The experience of the Great Recession showed that a borrower might keep paying even if she owes more than the house is worth.

Myth #3: You Need Perfect Credit to Qualify

Almost true! You need a nearly perfect credit to get the best rates on a conventional loan. But you don’t need a sky-high FICO score to qualify for a loan with a less favorable rate. In general, a score of 740 or higher qualifies you for the lowest rate. About 40 percent of loans bought by Fannie and Freddie in 2014 were to borrowers with credit scores from 620 to 739.

Conforming vs. Jumbo Loans: The Difference and Why It Matters

A conventional loan is any nongovernment mortgage. Conventional loans are not FHA, VA, or USDA loans.

Conforming loans are a subset of conventional loans, and follow the standards set by Fannie Mae and Freddie Mac. Because Fannie and Freddie buy most conventional loans, they set the standards by which all conventional loans are judged. If your mortgage amount is less than the upper limits set by Fannie Mae and Freddie Mac, it’s essentially a cookie-cutter process because the terms of the loan conform to their standards.

Jumbo loans exceed the maximum limits set by Fannie and Freddie. By definition, jumbo loans are nonconforming because they don’t have standard terms.

How much is a jumbo loan? That depends on where the house is located. The FHFA, which oversees Fannie Mae and Freddie Mac, sets the ceiling on conforming loans annually based on housing costs in each U.S. county. For most of the U.S., the threshold between conforming and jumbo is $417,000. That’s the loan limit for large swaths of the country, including all of Texas, Illinois, Ohio and Georgia, and much of Florida, Pennsylvania and North Carolina. In pricier parts of the nation the jumbo loan limit goes up. Honolulu has the highest limit for 2015, at $721,050. For much of Alaska and California, plus the New York metro area and the Washington, DC, area, the limit is $625,500. And in the Denver area, the conforming loan limit is $424,350. (See the calculator below to learn the conforming loan limits in your area.)

Conforming loans generally involve a less complicated application and approval process. Jumbo loans generally involve a more complex application and approval.

Research the current limits for conforming loans before you apply for a loan. How much you can afford, where you buy and the type of house.

Conforming Loan Limits for 2018

Click on your state to find the loan limit in your area.

Source: Fannie Mae and Freddie Mac

What Are Portfolio Loans?

In most cases, lenders avoid the risk of default by selling loans to Fannie Mae or Freddie Mac. But a few banks and credit unions actually want to keep their loans on their books. These so-called portfolio lenders sometimes offer good deals, especially on non-conforming loans. If you have unusual circumstances or are considering buying an unusual property, you might want to start by asking about a portfolio loan.

Portfolio lenders typically target only a narrow niche, says Brett Sinnott, vice president of capital markets at CMG Financial. They might offer a low rate, but only for properties that fit tight underwriting guidelines.

That description fits Palm Beach Community Bank in Florida. President Cal Cearley says his bank makes five or six “out-of-the-box” loans each month and keeps the mortgages in its portfolio. The bank might be willing to make a loan to someone with a recent short sale, for instance, so long as the borrower has no other credit blemishes. In another example, Cearley offered a loan to a borrower with little income but $5 million in stock investments. Fannie and Freddie wouldn’t buy the loan, but Cearley was confident the borrower could sell shares to make payments.

The Role of Fannie Mae & Freddie Mac in Conventional Mortgages

Fannie Mae (officially the Federal National Mortgage Association), and Freddie Mac (the Federal Home Loan Mortgage Corp.) are government-sponsored enterprises (GSEs). Congress chartered both to bolster stability and increase liquidity in the mortgage industry, as well as to promote affordability for homeowners and renters. Both buy loans from mortgage originators and bundle most into securities to sell to investors. By purchasing mortgages and guaranteeing loans — promising to pay investors in the event of a default — Fannie and Freddie create a source of steady funding so originators can extend more mortgage loans at affordable rates and terms, ultimately increasing the nation’s homeownership rate. Fannie Mae is the nation’s single largest issuer of mortgage-related securities.


Fannie Mae Freddie Mac

Home Purchase Loans

887,000 606,000

Refinance Loans

937,000 608,000

Loan Workouts

165,000 120,000

Loan Modifications

123,000 120,000

Purchase Loan Market Share

40% 20%

Average Borrower FICO score (weighted)

744 * 744 *

Average LTV ratio (weighted)

77% * 76% *

* At origination

Source: Fannie Mae and Freddie Mac annual reports for 2014

Both Fannie and Freddie benefitted from an implicit guarantee that the federal government will come to the rescue if they encounter financial trouble. The implicit guarantee allows the quasi-private businesses to secure money cheaply by selling bonds to investors. This guarantee became real during the 2008 housing crash — for which many experts place much of the blame on the GSEs — when Fannie Mae and Freddie Mac suffered crippling losses. In 2008, the FHFA placed the GSEs in conservatorship to keep them from going belly up, and the U.S. Department of the Treasury injected $187.5 billion in financial assistance to preserve their solvency.

Updated: December 26, 2018