Conventional Mortgage vs. Loan: What’s the Difference?

Conventional Mortgage vs. Loan

Conventional Mortgage vs. Conventional Loan: What’s the Difference?

An In-Depth Guide for Homebuyers

When it comes to buying a home, understanding your financing options is essential. Two of the most common ways to finance a home purchase are through conventional mortgages and conventional loans.

While these terms are often used interchangeably, there are key differences between them that can affect your mortgage terms, interest rates, and ultimately, the cost of homeownership.

If you’re planning to purchase a home, it’s important to know which type of loan is best suited to your financial situation, the price of the property you’re buying, and your long-term goals.

This guide will explore the key distinctions between conventional mortgages and conventional loans, help clarify some common confusion, and give you the information you need to make an informed decision.

What is a Conventional Mortgage?

A conventional mortgage is a type of home loan that isn’t insured or guaranteed by a government agency. It is issued by private lenders such as banks, credit unions, and mortgage companies.

These mortgages are often preferred by lenders because they typically carry fewer restrictions than government-backed loans like FHA, VA, or USDA loans.

However, conventional mortgages still have guidelines they must adhere to, particularly when they’re intended to be bought and sold by Fannie Mae or Freddie Mac, two government-sponsored enterprises (GSEs) that serve as secondary mortgage market participants.

Categories of Conventional Mortgages

Conventional mortgages can be categorized into two main types: conforming and non-conforming.

Understanding the difference between these two categories is key to understanding how a conventional mortgage works.

1. Conforming Conventional Mortgages

Conforming conventional mortgages meet the guidelines set by Fannie Mae and Freddie Mac, specifically in terms of loan size, creditworthiness, and income-to-debt ratios.

These loans adhere to conforming loan limits, which vary by county and are adjusted annually based on housing market conditions.

For 2024, the general conforming loan limit for a single-family home is $726,200, though it can go up to $1,089,300 in high-cost areas.

Because conforming loans adhere to these guidelines, they are eligible to be bought and sold by Fannie Mae and Freddie Mac.

This eligibility makes them more liquid in the secondary mortgage market and therefore more attractive to lenders. As a result, conforming loans tend to have lower interest rates and more favorable terms for borrowers.

2. Non-Conforming Conventional Mortgages

Non-conforming conventional mortgages, also known as jumbo loans, exceed the conforming loan limits set by Fannie Mae and Freddie Mac.

Because these loans cannot be purchased by GSEs, they are considered non-conforming and are typically offered by private lenders.

Non-conforming loans tend to have higher interest rates than conforming loans. This is because they carry more risk for the lender, as there’s less market liquidity, meaning it’s harder to sell the loan to investors.

Non-conforming loans are common for homebuyers in expensive markets, where property prices can exceed the limits set by Fannie Mae and Freddie Mac.

What is a Conventional Loan?

The term conventional loan is often used synonymously with conventional mortgage, but there can be a slight distinction, especially in technical definitions.

In some contexts, a conventional loan refers to any home loan that is not backed by a government agency such as FHA, VA, or USDA. Under this definition, both conforming and non-conforming mortgages would be considered conventional loans.

Essentially, all conventional mortgages are conventional loans, but not all conventional loans are conforming mortgages.

To avoid confusion, we’ll refer to both conforming and non-conforming loans as conventional loans, recognizing that the critical distinction lies in whether or not the loan meets the GSE guidelines and the loan limits set by Fannie Mae and Freddie Mac.

Key Differences Between Conventional Mortgages and Conventional Loans

While the terms “conventional mortgage” and “conventional loan” are often used interchangeably, there are distinct differences that can impact your ability to secure financing and the cost of your loan.

Understanding these differences is key to choosing the right loan for your needs. Here’s a breakdown of the major distinctions:

1. Government Backing

• Conventional Mortgages: These may or may not be backed by Fannie Mae or Freddie Mac, depending on whether the loan is conforming or non-conforming. If the loan adheres to GSE guidelines, it is eligible for purchase by Fannie Mae or Freddie Mac.
• Conventional Loans: These are not backed by any government agency. Conventional loans, by definition, are issued by private lenders without the guarantee of a government entity like the FHA, VA, or USDA. This category includes both conforming and non-conforming loans.

2. Loan Limits

• Conventional Mortgages: The loan limit for conforming conventional mortgages is restricted by Fannie Mae and Freddie Mac’s guidelines, which change annually and vary depending on the area in which you’re purchasing. The maximum limit for conforming loans for a single-family home in most parts of the U.S. is around $726,200, though higher limits apply in certain high-cost areas (up to $1.1 million).
• Conventional Loans: This term encompasses both conforming and non-conforming loans, which can exceed the limits set by Fannie Mae and Freddie Mac. Jumbo loans are a type of non-conforming loan that allows you to borrow amounts greater than the conforming loan limit. In expensive markets, a jumbo loan might be required to finance the cost of a home.

3. Interest Rates

• Conventional Mortgages: Because conforming loans can be sold to Fannie Mae or Freddie Mac, they are considered less risky for lenders, resulting in lower interest rates. In general, conforming loans offer more favorable terms and lower interest rates.
• Conventional Loans: Non-conforming loans, including jumbo loans, are more expensive due to the lack of liquidity from GSEs. The interest rates on conventional loans that exceed the conforming loan limits tend to be higher as these loans carry a greater risk for lenders.

4. Credit Score Requirements

• Conventional Mortgages: These loans generally require a higher credit score than government-backed loans. A score of 620 or above is typical for conforming loans, but the best rates may require a score of 740 or higher. Non-conforming loans may require an even higher score, especially for jumbo loans.
• Conventional Loans: Conventional loans (which include both conforming and non-conforming) may offer more flexible credit score requirements. For example, some non-conforming loans may be available to borrowers with lower scores, though they often come with higher rates or larger down payment requirements.

5. Down Payment Requirements

• Conventional Mortgages: A typical minimum down payment for conforming loans is 3%, but it can be higher for non-conforming loans. For non-conforming loans (especially jumbo loans), the required down payment may range from 5% to 20% or more.
• Conventional Loans: The down payment requirements for conventional loans that exceed conforming limits (i.e., jumbo loans) are typically higher due to the increased risk to lenders. Jumbo loans may require at least 10% to 20% down, depending on the size of the loan and the lender’s requirements.

Advantages and Disadvantages of Conventional Mortgages and Loans

Understanding the pros and cons of conventional mortgages and loans can help you make an informed decision based on your personal financial situation. Below, we outline the advantages and disadvantages of each.

Advantages of Conventional Mortgages

1. Lower Interest Rates: Due to their eligibility for purchase by Fannie Mae and Freddie Mac, conforming loans typically come with lower interest rates compared to non-conforming loans.
2. More Flexible Credit Score Requirements: While conventional mortgages generally require a higher credit score than government-backed loans, they still offer some flexibility. Borrowers with solid credit scores (around 740 or higher) can benefit from the best available rates.
3. Lower Private Mortgage Insurance (PMI) Premiums: If your down payment is less than 20%, you may still be required to pay PMI on a conventional mortgage, but the premiums are generally lower than on FHA loans.
4. Wide Range of Loan Terms: Conventional mortgages come in a variety of terms, such as 15-year, 20-year, and 30-year options, which provide borrowers flexibility in choosing a loan term that suits their financial goals.

Disadvantages of Conventional Mortgages

1. Stricter Credit Score Requirements: While conventional mortgages offer flexibility, they still generally require a higher credit score than some government-backed loans like FHA or VA loans. This could be a barrier for buyers with poor credit.
2. Higher Down Payments: Conventional mortgages typically require a larger down payment than government-backed loans. While you can get a conventional loan with as little as 3% down, you may need a larger down payment for non-conforming loans, such as jumbo loans.
3. Private Mortgage Insurance (PMI): If your down payment is less than 20%, you will likely have to pay PMI until you reach 20% equity. This can add to your monthly mortgage costs.

Advantages of Conventional Loans

1. Higher Loan Limits: Conventional loans, especially jumbo loans, allow you to borrow more money, which is helpful if you are purchasing a higher-priced property. In expensive areas, these loans can exceed the conforming loan limits, making them a viable option for luxury homes or large properties.
2. Flexible Credit Score Requirements: Non-conforming loans may offer more flexible credit requirements for borrowers with less-than-perfect credit, making them a potential option for buyers who don’t meet the stricter standards of conventional mortgages.
3. More Financing Options: Conventional loans offer a variety of loan types for borrowers, including fixed-rate and adjustable-rate options. For those with specialized financial needs, these can provide more tailored solutions.

Disadvantages of Conventional Loans

1. Higher Interest Rates: Since non-conforming loans, such as jumbo loans, are riskier for lenders, they often come with higher interest rates than conforming conventional mortgages.
2. Larger Down Payments: Many conventional loans, especially non-conforming loans, require a larger down payment. You may need to put down 10% to 20% or more to qualify for a loan.
3. Less Availability: Non-conforming loans are not as widely available as conforming loans, especially for smaller or mid-sized lenders. This means you might have fewer options for lenders and may have to search more carefully for the best deal.

How to Choose Between a Conventional Mortgage and Loan

When deciding between a conventional mortgage and a conventional loan, consider the following factors:

1. Your Credit Score: If you have a strong credit score (typically 700 or higher), a conventional mortgage will likely provide the best interest rates and terms. However, if your credit is less than perfect, a conventional loan may be more accessible, especially for jumbo loans.
2. Down Payment Size: If you can afford a larger down payment, a conventional mortgage may offer lower rates and reduced PMI costs. However, if your down payment is small, you may need to consider conventional loans that offer more flexible down payment options.
3. Loan Amount: For homes in high-cost areas, a conventional loan (especially a jumbo loan) might be necessary to meet your financing needs. In such cases, the higher interest rates and larger down payments are often offset by the ability to finance a more expensive property.
4. Interest Rates and Loan Terms: Compare interest rates and loan terms from multiple lenders. A 15-year term may be better for some borrowers who want to pay off their home more quickly, but a 30-year term may offer more affordability in the short term.

Final Thoughts

In conclusion, understanding the differences between conventional mortgages and conventional loans is crucial when deciding how to finance your home purchase.

By carefully weighing your credit score, down payment capabilities, and the size of your loan, you can choose the best option for your financial situation and goals.

Whether you opt for a conforming mortgage, a jumbo loan, or another type of conventional loan, it’s important to consult with a mortgage professional to ensure you’re getting the most favorable terms.