A comprehensive guide to conventional mortgages

Conventional mortgages are the most common type of home loan issued in the United States. Researching conventional loans is a great place to start when you're deciding between home loan options. The mortgages are typically best suited for homeowners with good credit, regardless of your household income.

This guide details your different options when receiving a Conventional mortgage, which include:

• Fixed Rate Conventional Mortgages: home loans that charge a set interest rate that lasts the life of the loan, resulting in reliable monthly payments.
• Adjustable Rate Mortgages (ARMs): loans that begin with a set interest rate, usually below the market rate on a comparable fixed-rate mortgage.
• HomeReady & HomePossible Loans: fixed rate loans designed for creditworthy, low-income borrowers.
• Jumbo Loans: Conventional loans designed to finance luxury properties and homes in high-priced areas, jumbo loans come with unique underwriting requirements and tax implications.

What is a Conventional Mortgage?

Conventional mortgages are technically all those not backed by a government program or funding. Instead, they are funded and insured by private lenders. A conventional mortgage can be either conforming or non-conforming. The Federal Housing Finance Agency (FHFA) reviews and adjusts loan limits annually to keep up with the pace of the housing market.

Generally, conventional loans come with low interest rates, low fees and great options for first-time or repeat homebuyers. There are some basic requirements to qualify for a conventional loan. At the very least, you’ll need a down payment of at least 3% to 5% (depending on the program), a fair credit score (620 or above), a low debt-to-income ratio (DTI), and a loan amount within the area limit to qualify.

The Federal Housing Finance Agency (FHFA) reviews and adjusts loan limits annually to keep up with the pace of the housing market. There is a national baseline with adjustments for any “high-cost areas,” so your exact loan limit will depend on the area you are buying. Anything over the area limit would be considered a Jumbo loan. Use our online calculator to find loan limits in your city or county of interest.

Conventional loans offer fixed or adjustable rates. Fixed rates are reliable through the life of the loan. Adjustable-rate mortgages are subject to change at every adjustment period based on the fully indexed rate.

Fixed Rate Conventional Mortgage

Fixed rate mortgages charge a set interest rate that lasts the life of the loan, resulting in reliable monthly payments.

Many borrowers love fixed-rate loans for how dependable they are. A fixed interest rate, regardless of loan program, guarantees a consistent principal and interest payment throughout the life of the loan, which allows for a reliable and gradual amortization. Before accepting any loan, you can input different terms into an amortization calculator to understand when—with consistent monthly payments—you’ll have the loan paid off. Using the same tool, you can also track exactly how much money per month goes toward principal and how much goes toward interest.

The only time the monthly payment on your fixed-rate mortgage may change is for escrow. Property tax rates and insurance premiums adjust regularly (typically every 12 months) and your escrow will adjust in accordance.

Adjustable Rate Mortgage (ARM)

Adjustable-rate mortgages (ARMs) begin with a set interest rate, usually below the market rate on a comparable fixed-rate mortgage.

When shopping ARMs, it’s common to see the initial rate and adjustment period represented in a short-hand fraction. For example, a 7/6 ARM will carry a fixed rate the first 7 years of the loan and then adjust every 6 months after.

The amount any rate adjusts will depend on the fully-indexed rate at the time of adjustment, as well as any adjustment caps in place to limit the amount the rate can go up or down. A fully indexed rate is the combination of the index and the fixed margin on the mortgage, both chosen by the lender.

The cap is also set by the lender. You will go over the specific terms of your ARM in detail with your loan officer. It is important to understand the terms in full before accepting the loan. You should not just assume you can refinance later.

HomeReady & HomePossible Mortgages

HomeReady and HomePossible mortgages are conventional loan products designed for creditworthy, low-income borrowers.

HomeReady Mortgages (Fannie Mae)

Repeat buyers may be eligible, but this product is most often selected by first-time homebuyers. Borrowers using the HomeReady program will pay less credit-related fees and only need a3% down payment. If you have a credit score of at least 620 and as little as 3% available for a down payment, you may qualify for a HomeReady loan. Borrowers with a 680 credit score or greater may qualify for even better terms.

HomeReady is more than just a low down payment option, there is also no required minimum contribution. This means that you are not technically required to use any of your own assets for the down payment. You could pay all 3% in gifts. A “gift” is any funding coming from an outside source without  required payback.

Another major advantage of the HomeReady program is the reduced mortgage insurance coverage requirement for loan-to-value ratios above 90%. This means that you can pay the minimum 3% down and still enjoy great pricing on mortgage insurance. HomeReady also permits the use of supplemental boarder or rental income for qualification. All that means is that underwriters can accept part of any leased renter’s rent as qualifying income, which can be a huge advantage in your debt-to-income (DTI) calculation and may help you qualify for more financing.

What are the income requirements for HomeReady?

To qualify for HomeReady, you cannot make more than 80% of your area's median income (AMI). So, if your area—broken down by census tract—has a median yearly income of $100,000, you must make $80,000 or less to qualify for the HomeReady program. Fannie Mae offers a simple tool to look up any area’s median income.

HomePossible Mortgages (Freddie Mac)

Home Possible is a conventional loan product from Freddie Mac designed for creditworthy, low-income borrowers.

Repeat buyers may be eligible, but Home Possible loans are ideal for first-time homebuyers. Borrowers using the Home Possible program will pay less credit related fees and are only required to provide 3% down at closing. If you have a credit score of at least 660 and as little as 3% available for a down payment, you may qualify for a Home Possible loan.

Home Possible offers a low down payment option with no minimum contribution requirement, meaning you can secure a home without having to use any of your own assets for the down payment. It is possible to pay for it entirely with “gift” money. A gift is any funding coming from an outside source that is given without any required payback.

Another advantage of the Home Possible program is the reduced mortgage insurance coverage requirement for loan-to-value (LTV) ratios above 90%. Home Possible also allows for supplemental boarder or rental income, meaning you may use part of the income from any leased renter to help qualify. This is a huge advantage in your debt-to-income (DTI) calculation and may help you qualify for more financing.

What are the income requirements for HomeReady & HomePossible?

To qualify for Home Possible, you cannot make more than 80% of your area's median income (AMI). What this means is that if your area – broken down by census tract – has a median yearly income of $100,000, you must make $80,000 or less to qualify for the Home Possible program. Freddie Mac offers a simple tool to discover your or any AMI and gauge eligibility.

What types of homes are eligible for HomeReady and HomePossible?

• 1-4 Unit Properties: One unit properties include attached and detached single-family homes. Two to four unit properties have one to three extra livable units to rent out.
• Manufactured Homes: Manufactured homes are transportable in one or more sections that sits on a permanent foundation.
• Condos: A real estate project in which each unit owner has title to a unit in a building, an undivided interest in the common areas of the project, and sometimes the exclusive use of certain limited common areas.
• Planned-Unit Developments: A project or subdivision that includes common property that is owned and maintained by a homeowners' association for the benefit and use of the individual PUD unit owners.

Jumbo Loans

Designed to finance luxury properties and homes in high-priced areas, jumbo loans come with unique underwriting requirements and tax implications.

Like other conventional mortgages, these loans are underwritten and insured by private lenders and not backed by any government entity – FHA, VA or USDA. Due to their size, they do not fit the criteria set by the Federal Housing Finance Agency (FHFA) and are not eligible for purchase by Fannie Mae or Freddie Mac.

Since these are non-conforming conventional loans, they’re considered higher-risk. Most lenders underwriting jumbo loans will still use Fannie Mae and Freddie Mac guidelines as a base, but add special overlays. Therefore, applicants regularly face more stringent underwriting. For instance, jumbo loans often require a higher down payment or equity, sometimes as high as 30%, and lenders look for a higher credit score. Finally, you will likely notice a higher interest rate attached to Jumbo loans.