What Is a Conventional Loan?

A conventional loan is a mortgage from a private lender that isn’t insured by a government agency such as the Federal Housing Administration, Department of Veterans Affairs, or Department of Agriculture. Conventional loans typically cost less than FHA loans, and don’t always require mortgage insurance. However, conventional loans also have stricter eligibility requirements, so they can be more difficult to get.

How does a conventional mortgage work?

A conventional loan is, like most mortgages, used to buy or refinance a home.

The loan is a contract stating that the lender will advance money for the borrower to buy a home, and the borrower will repay that amount — along with interest — following a regular schedule of payments. If the borrower fails to pay as agreed, the lender can sell the property to cover its costs related to the loan.

Lenders offer a range of conventional mortgage rates, repayment terms, and other features that depend on the specific lender, the property, and the borrower’s financial situation and personal preferences. They are prohibited from discriminating against borrowers based on race, color, religion, national origin, sex, marital status, age, or participation in income assistance programs. By law, mortgage approval decisions must be based on factors such as credit history, income, and existing debts.

The interest rate offered on a conventional mortgage depends on several factors, including the borrower’s credit score and down payment. This mortgage rate is important in determining their total cost to borrow.

Types of Conventional Loans

Conventional loans come in two main types: conforming and nonconforming.

Conforming mortgages meet federal requirements that allow Fannie Mae and Freddie Mac — government-sponsored enterprises — to guarantee the loan. Fannie and Freddie do this by buying mortgages from lenders. They either hold those mortgages in their portfolios or repackage them into securities that are sold to investors on what’s called the secondary mortgage market. That frees up cash for lenders to extend more home loans.

Nonconforming loans don’t meet federal requirements and are less standardized.

Conforming mortgages

The defining characteristic of conforming loans is they don’t exceed the Federal Housing Finance Agency’s maximum loan amount. The FHFA sets a default limit that applies to most places in the United States, and a high-cost limit for areas where market prices for homes are higher.

Fannie and Freddie also set eligibility standards for borrowers, including debt-to-income ratio and credit score requirements. Individual lenders may have other requirements and request additional documentation.

Conforming loan limits in 2022

In 2022, conforming loans for a single-family home cannot exceed $647,200 in most areas. For high-cost areas, the limit is $970,800. Here are the conforming loan limits through the end of 2022:

FHFA Conforming Loan Limits in 2022

1 unit2 units3 units4 units
Baseline limit$647,200$828,700$1,001,650$1,244,850
High-cost area limit$970,800$1,243,050$1,502,475$1,867,275
Source: Federal Housing Finance Agency

If the home you want to buy exceeds these limits, then you’ll need a nonconforming loan.

Nonconforming mortgages

Lenders set their own terms for nonconforming loans, and they can vary significantly.

Many nonconforming loans fall into the category of jumbo loans. These can go up to $2 million, though borrowers need good credit and a large down payment to qualify.

Some nonconforming loans are geared toward people with poor credit, and may come with higher interest rates and risky features. For example, they might require less documentation to verify the borrower’s income, or allow borrowers to only pay interest on the mortgage.

Other nonconforming loans are niche programs designed for borrowers with unusual circumstances, or mortgages of any size that just don’t belong to another category.

Because nonconforming loans can be risky, the Consumer Financial Protection Bureau advises borrowers to consult multiple lenders and look into FHA loans or conforming loans before committing to this type of mortgage.

Conventional Loan Requirements: How Do You Qualify?

Lenders go through a detailed review process when approving mortgages. Below are some of the most important requirements for a conforming loan:

Eligibility Requirements for a Conventional Mortgage

Type of requirementEligibility requirement
Credit scoreAt least 620
Debt-to-income ratio50% or under (36% for manually underwritten loans; 45% for borrowers who meet other requirements)
Income and assetsEnough income and assets to cover your monthly mortgage payments, even in the event of a financial emergency
Down paymentAt least 3% of the total value of the loan
PropertySingle-family homes, condos, second homes, investment properties

Credit score

Your credit score is a number that represents your borrowing risk for lenders. A credit score is a number that tells lenders how likely a borrower is to repay a loan, based on their previous experiences with credit. Using the FICO system, most credit scores range between 300 and 850. Borrowers need a credit score of at least 620 to qualify for a conventional loan. Individual lenders may have additional requirements.

Debt-to-income ratio

Your debt-to-income ratio is a percentage calculated by adding up your monthly debt obligations and dividing the sum by your total monthly income before taxes.

Conventional mortgage requirements allow for a maximum DTI ratio of 50%. If you earn $5,000 per month before taxes, for example, then your monthly debt payments should take up less than $2,500 of your income. For manually underwritten loans, the maximum DTI ratio is 36%, or 45% if the borrower can meet additional credit score and reserve requirements.

Income and assets

Your income is examined in multiple ways when you apply for a mortgage. Lenders look at your total income to determine whether you can afford the projected monthly payment. There’s no minimum income requirement to get a conventional mortgage, but it’s often easiest to get approved if you can prove that you’re earning steady income.

Lenders also evaluate your assets to figure out whether you can afford to continue making your mortgage payments in the event of a financial emergency, like job loss. These assets include checking accounts, savings accounts, certificates of deposit, individual retirement accounts, 401(k) accounts, stocks, bonds, and mutual funds.

Down payment

Conforming loans require borrowers to make a down payment. Fannie and Freddie both have programs that allow buyers to put down as little as 3%. If you don’t qualify, you’ll need to put down 5% or more. Exactly how much you need for a down payment can vary, but buyers who put down less than 20% of the home purchase price typically must pay for private mortgage insurance.

A larger down payment reduces both the amount you need to borrow to buy a home and the size of your monthly payment. If you’re struggling to get approval for a mortgage, consider saving up for a larger down payment to increase your odds. Putting more money down also could help you get a lower interest rate.

Property

Because a property secures a mortgage, the home itself is an important factor in getting approved for a loan. Lenders typically appraise a property to determine how much it’s worth, and therefore how much they will lend to you. The home appraisal helps decide whether the mortgage will remain within the FHFA limits for a conforming loan, as well as how much of a down payment is required to get the loan and avoid paying PMI.

Properties that are eligible for conventional financing include single-family homes, condos, townhouses, and co-ops.

Advantages and Disadvantages of Conventional Loans

While conventional loans are the most common type of mortgage, they aren’t the best option for everyone. Consider the different pros and cons when shopping around.

Advantages of a conventional mortgage

  • Lower total cost. Conventional mortgages often are the most affordable option for homebuyers who have good credit and a down payment of 10% to 15%. One way to compare costs is using the loan’s annual percentage rate, which represents the interest rate and other fees. Your APR will be listed on Page 3 of each loan estimate you receive from lenders.
  • Widely available. You can find a conventional loan through most major banks, credit unions, and other types of lenders.
  • Some flexibility in terms. When choosing a conventional loan, you can select a longer or shorter loan term, or a fixed-rate or adjustable-rate mortgage.
  • No PMI required with a 20% down payment. Paying mortgage insurance is mandatory for all FHA loans, but you can avoid PMI on a conventional loan if you put down 20%.This helps you save money on your mortgage.

Disadvantages of a conventional mortgage

  • Stricter credit score requirement. Conventional loans generally require higher credit scores compared with mortgages backed by government programs, so it can be more difficult to qualify.
  • Higher down payment requirement. To get a conventional loan, you typically need a down payment of at least 5%, unless you qualify for special programs. Some government-backed loans allow borrowers to make a smaller down payment or no down payment at all.
  • PMI requirement. You can expect PMI payments to cost $30 to $70 per month for every $100,000 you borrowed. If you can’t afford to put down 20%, then PMI will be an additional expense until you reach 20% equity in your home. Equity is the difference between your home’s value and how much you still owe on your mortgage.

Alternatives to Conventional Loans

If a conventional loan isn’t right for you, there are other types of mortgages out there. These include government-backed loans, such as:

Conventional loans vs. FHA loans

If you don’t qualify for a VA or USDA loan, you may be deciding between an FHA loan and a conventional loan.

Conventional loans are often less expensive for those who have good credit and a sizable down payment. FHA loans tend to be cheaper for borrowers with lower credit scores and less saved up. An FHA loan is easier to get, which means it’s a good option for first-time homebuyers, but making a larger down payment with a conventional loan saves money in the long run.

Here are the significant features of FHA loans vs. conventional mortgages:

Conventional Loans vs. FHA Loans

FeatureConventional loanFHA loan
Minimum down payment3%3.5%
Minimum credit score620500
Insurance required?Private mortgage insurance, if putting less than 20% downMortgage insurance, including an upfront premium and a monthly premium

Conventional loans vs. VA loans

VA loans are available for eligible service members, veterans, and their surviving spouses. This type of loan is made by private lenders and insured by the Department of Veterans Affairs.

Compared to conventional mortgages, VA loans can be more affordable and easier to get for borrowers who qualify. The VA doesn’t have a minimum credit score requirement, and borrowers often don’t need to put any money down. VA loans also don’t require mortgage insurance, unlike FHA loans and some conventional loans, though borrowers must pay a one-time VA funding fee.

These are important features of VA loans vs. conventional mortgages:

Conventional Loans vs. VA Loans

FeatureConventional loanVA loan
Minimum down payment3%No minimum down payment
Minimum credit score620No minimum credit score; depends on lender
Insurance required?Private mortgage insurance, if putting less than 20% downNo mortgage insurance, but a one-time VA funding fee

Conventional loans vs. USDA loans

The Department of Agriculture offers a loan program for low-income borrowers who want to buy a home in an eligible rural area.

Compared to conventional loans, which are widely available, USDA loans limit how funds can be used and require borrowers to meet income eligibility. Borrowers also must pay an upfront guarantee fee and an annual guarantee fee. However, USDA loans don’t come with a minimum down payment requirement, which means they can be a good option for qualified borrowers with little savings.

Here are the significant features of USDA loans vs. conventional mortgages:

Conventional Loans vs. USDA Loans

FeatureConventional loanUSDA loan
Minimum down payment3%No minimum down payment
Minimum credit score620No minimum credit score, though a score of 640 or higher is best
Insurance required?Private mortgage insurance, if putting less than 20% downNo mortgage insurance, but an upfront guarantee fee and an annual guarantee fee

How To Get a Conventional Loan

You can find a conventional loan by working directly with a lender or mortgage broker, and use online tools to help you evaluate multiple loan options at once.

For an initial loan estimate, plan on submitting the following:

  • Your name.
  • Your income.
  • Your Social Security number.
  • The property address.
  • An estimate of the property’s value.
  • The anticipated loan amount.

For a complete mortgage application, you’ll need to submit additional documentation, including pay stubs, W-2 forms, income tax returns, bank statements, investment account statements, and anything else required to substantiate your income and assets.

Your lender may reach out with more questions and documentation requests. If that happens, try to respond quickly with complete and accurate details to help ensure a smooth mortgage approval process.

The Bottom Line on Conventional Loans

Conventional mortgages are the most affordable type of loan for qualified borrowers in many cases. If you have a solid financial foundation, then a conventional loan can deliver a lower interest rate and more-affordable fees. If that doesn’t sound like you, or if you’re a veteran or rural borrower, consider an FHA, VA, or USDA loan as an alternative mortgage option to buy your ideal home.

Rory Arnold contributed to the reporting of this article.

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