Conventional loans

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As the name suggests, conventional loans are the most common way to finance a home. These are the basic loans that aren't insured by branches of the federal government.

The requirements for a conventional mortgage will be stricter, so these loans are typically available only to a borrower who has a solid credit score.

Conventional mortgages are split into conforming and nonconforming loans. Conforming mortgages have dollar-amount limits set by Fannie Mae and Freddie Mac, two government-sponsored companies that buy and guarantee most U.S. home loans. In 2021, the limit is $548,250 in most parts of the U.S.

Nonconforming mortgages, or jumbo loans, go beyond the limits. Without the backing from Fannie and Freddie, nonconforming loans are considered riskier for lenders and often come with higher interest rates and down payment requirements.

Conventional Loan vs. FHA.

A walkthrough on the requirements of two common mortgage programs

See Guide

Pros of conventional loans

  • Quicker approvals. These loans usually require less paperwork, meaning you can get approved quickly.
  • More options. You can customize a conventional mortgage depending on your needs: conforming or nonforming, different term lengths or fixed or adjustable rates.

Cons of conventional loans

  • Solid credit needed. You’ll need a credit score of around 620 at the minimum to be considered, and higher still to land a low mortgage rate.
  • PMI If you can’t muster a 20% down payment, you’ll likely need to pay for private mortgage insurance (PMI) to protect the lender in case you can't pay back the loan.

FHA loans

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FHA loans are insured by the Federal Housing Administration and are designed to help first-time homebuyers and those with lower or middle incomes.

While the loans are issued by private lenders, the government takes on some of the risk if you can’t make your payments.

With less risk for the lender, the barriers for FHA loans are lower: You can get approved with a credit score as low as 500, and you may be eligible for for a down payment of only 3.5%

FHA mortgages aren't just for homebuyers — you can use one to refinance an existing mortgage or even cash out some equity to make repairs to an older home.

Pros of FHA loans

  • Easier to get. You can still get a loan even with a much lower credit score and down payment.
  • Flexible home type. These loans can be applied to different housing types: single-family homes; multifamily buildings with up to four units; or condominiums.
  • No income limit. Unlike some other government-backed loans, the FHA program doesn’t apply a limit to how much you can earn. That opens up eligibility to more potential homebuyers.

Cons of FHA loans

  • Insurance costs. FHA loans come with mortgage insurance premiums (MIPs). One is paid upfront, and the other is paid monthly throughout the life of the loan.
  • Lower loan limits. The maximum in most counties in the U.S. is $356,362 in 2021. In more expensive housing markets, the limit can be as high as $822,375.
  • Primary residence only. You can get an FHA mortgage only to finance your primary residence, not a vacation home or investment property.

The FHA's Loan Requirements Explained.

A walkthrough of how to meet the FHA's requirements.

See Guide

USDA loans

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USDA loans are available to low- and middle-income borrowers in rural and suburban areas. These mortgages are guaranteed by the United States Department of Agriculture and require no down payment.

Qualifying for a USDA loan will depend on your income and county. You can see local income limits in the USDA map and table.

Pros of USDA loans

  • Flexibility. There are flexible credit and qualifying guidelines.
  • Get 100% financing. Save your money for your monthly payments — with USDA loans you might be eligible to buy a home with no down payment.
  • Refis possible. You can secure these loans for both purchase or refinance mortgages.

Cons of USDA loans

  • Strict limits. There are income limits and geographic restrictions, meaning your area may not qualify.
  • Insurance costs. The USDA requires borrowers to pay mortgage insurance, both upfront and annually. But the USDA insurance is much less expensive than for other loan programs.
  • ** Strict home types.** USDA loans are available only for single-family, owner-occupied homes.

VA loans

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Rounding out the government-backed mortgage options are VA loans. These are mortgages backed by the U.S. Department of Veterans Affairs for active service members, veterans, and some surviving military spouses

Like USDA loans, you can secure a mortgage with no down payment, and VA loans also come with no mortgage insurance. But borrowers do pay an upfront funding fee, which can be as high as 3.6% of the total amount of the loan.

Pros of VA loans

  • Get 100% financing. As long as the sale price doesn’t exceed the appraised value of the home, no down payment is needed.
  • Lower closing costs. The VA limits the amount lenders can charge for closing costs and fees. Often, sellers will take care of closing costs if buyers can negotiate them into the deal.
  • No PMI required. No mortgage insurance is required, even for borrowers making a 0% down payment.

Cons of VA loans

  • Loan limits. Technically, the VA doesn’t set loan limits. But the department does limit the guarantee it makes to the private lenders who issue the loans, so good luck getting VA financing on your colossal mansion.
  • Primary homes only. As with other government-backed mortgages, VA loans can be used only for owner-occupied residences.
  • The funding fee. The actual fee will depend on the loan type, military category, whether it’s your first VA loan and if you make any down payment.

Fixed-rate mortgages

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With a fixed-rate mortgage, borrowers pay a steady monthly payment over a set number of years. The interest rate is fixed, meaning it won’t ever change for the life of the loan.

The certainty makes these loans pretty popular among borrowers.

Pros of fixed-rate mortgages

  • No surprises. It’s helpful to know that if interest rates suddenly spike, yours won’t budge.
  • Steady monthly payments. Want to make budgeting a lot simpler? With locked-in rates, your monthly mortgage payment will never change.
  • Flexible term options. Fixed-rate mortgages come with plenty of term options: Lenders will offer 10, 15, 20, 25 and 30 years.

Cons of fixed-rate mortgages

  • Frozen rates. Now the other shoe drops: If rates decline dramatically, [as they have in 2020]((https://moneywise.com/a/how-to-take-advantage-of-cheap-mortgages), you’re stuck at the higher rate unless you refinance.
  • Higher interest rates. If you’re looking for the absolute best interest rates — at least to begin with — you’ll have better luck looking at adjustable-rate mortgages.
  • Higher monthly payments. With higher interest rates, you can count on higher monthly payments. That leads to a secondary issue: A higher monthly payment amount might limit the size of the mortgage you can qualify for.

How to Get a Mortgage.

Just break the mortgage process down into a few smaller steps. Here's how.

See Guide

Adjustable-rate mortgages

A man holds a red arrow up above the word Rate and a wooden house.
Andrii Yalanskyi / Shutterstock

With an adjustable-rate mortgage, or ARM, the interest rate is only fixed at first — normally for three to seven years.

ARMs are described in terms of two numbers, which stand for the number of years of the initial fixed period, and the frequency — in years — of potential rate changes once the loan starts "adjusting."

With a 5/1 ARM, for example, the rate will hold steady for the first five years, and then is subject to change annually (every one year that follows). The rates adjust in sync with the prime rate or some other benchmark interest rate.

Pros of ARMs

  • Low initial rate. ARMs normally have lower rates than fixed-rate mortgages, at least to start with. That means you can enjoy smaller monthly payments, and potentially secure a larger total mortgage amount.
  • Short-term benefit. If you know you’re going to own your home for just a short, set period of time, you can enjoy an ARMs lower rates while they're fixed.
  • Potential to go even lower. During the adjustable-rate period, your mortgage rate has the potential to fall if other rates decline.

Cons of ARMs

  • Less certainty. Budgeting isn’t easy during the best of times. But it becomes even more complex if your housing costs suddenly change. ARMs might be difficult if you prefer the peace of mind that comes with stability.
  • Rates could increase. You take the good with the bad. Nobody can tell you if rates will go up or down, and you could end up paying much higher interest in the long run.
  • Potentially higher payments. If rates do start moving higher, your mortgage payment is going to increase. You might be able to weather that kind of change now, but you don’t know what your financial situation will look like in the future.

The Best Lenders for a Mortgage

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About the Author

Ethan Rotberg

Ethan Rotberg

Reporter

Ethan Rotberg is a staff reporter at MoneyWise. His background includes nearly 15 years as a writer, editor, designer and communications professional. He loves storytelling, from feature writing to narrative podcasts. His work has appeared in the Toronto Star, CPA Canada and Metro, among others.

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