A “conventional” mortgage is any mortgage loan that meets the guidelines set by Fannie Mae (FNMA) and Freddie Mac (FHLMC), which are government sponsored enterprises (GSEs) that support the mortgage market. At 80%+ of all outstanding mortgage loans, conventional loans are the most popular mortgage program in the US. Conventional loans are not guaranteed by the US government, like FHA loans, for example. Instead, when a mortgage meets GSE guidelines, it’s eligible to be purchased and resold by the GSEs (more on what that means below).
All things being equal, conventional mortgages will have lower interest rates than a loan that does not meet Fannie/Freddie guidelines, but they may have stricter credit score and income qualifications than other types of loans.
Conventional loans can be used to finance primary residences, second homes, and investment properties. Mortgages on primary residences will generally have lower interest rates than second homes or investment properties.
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<aside> 💡 What are GSEs? Fannie and Freddie are government sponsored enterprises (GSEs), which means that, although they were created by Congress, they are technically private enterprises. Their purpose is to support the flow of credit and liquidity into the US mortgage market and thereby promote homeownership in the US. They are not lenders and do not originate mortgage loans. Instead, they purchase the mortgages made by lenders and guarantee their repayment. They then package loans into mortgage-backed securities (MBSs) and sell them to large financial institutions. By guaranteeing repayment in exchange for a fee, the GSEs increase the value of MBSs, make them more liquid and tradeable, and thereby increase demand for them. This helps support the flow of liquidity and credit to the mortgage market and results in lower interest rates for borrowers.
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Whether a loan is a conforming conventional loan or a non-conforming one has to do with the size of the loan. The Federal Housing Finance Agency (FHFA) sets an annual threshold called the conforming loan limit. The nationwide conforming loan limit for 2023 is $726,200. Conventional loans less than that amount are also considered conforming loans and generally have lower interest rates.
In certain high-cost areas, like in San Francisco for example, a loan limit of $726,200 effectively won’t allow you to buy a home at all. So the FHFA makes adjustments to the conforming loan limits for high cost counties. San Francisco’s is $1,089,300. A mortgage less than that amount, but greater than $726,200, is considered a high balance conforming loan. Loans greater than the conforming amount set for a particular county are referred to as jumbo loans. These loans are typically ineligible to be purchased by Fannie/Freddie.
Everything else being equal, a conventional conforming loan will have a lower interest rate than a conventional conforming high-balance loan, which will usually have a lower interest rate than a jumbo loan.
The 30-year fixed rate mortgage is by far the most common type of home loan and, under U.S. law, it’s considered a “traditional” mortgage. Many buyers choose a conventional 30-year fixed rate mortgage because it generally results in a low, fixed monthly payment.
But conventional loans can also come in the form of other mortgage products as well. Conventional loans can have different terms like 15-year fixed or 20-year fixed loans. Conventional loans can also include adjustable rate mortgages (ARMs), also known as “hybrid ARMs”, where the interest rate is fixed for a certain period (e.g., 3, 5 or 7 years) and then the interest rate adjusts every year thereafter. Yet another option for conventional loans are interest-only (I/O) ARMs, which allow the borrower to pay only interest (and not principal) repayments for a set period of time, typically 10 years.
Lenders have a lot of flexibility to offer a variety of products under the conventional mortgage program.
It used to be the case that conventional loans were defined in large part by the standard 20% down payment (thus the borrower finances 80% of the home’s value). Over recent years, however, conventional loan programs with lower down payment requirements have been rolled out.
Fannie Mae offers the HomeReady program, a home affordability product that allows borrowers to put down as little as 3% of the home’s value as down payment (borrowing 97% of rest). This program helps people who have limited upfront funds but requires a good credit history and a good debt-to-income ratio.
Freddie Mac offers its own 3% down program, Home Possible, which is a home affordability product that aims to support low-to-moderate income buyers in certain low-income areas.
Generally speaking, making larger down payment will result in a lower interest rate.