When you begin exploring mortgage options for buying a home, you’ll come across various types, including conventional loans. These are the most widely used home loans and are offered by nearly all mortgage lenders. So, what exactly is a conventional mortgage? Here’s a comprehensive overview of this popular choice for financing a home purchase.

What is a conventional loan?

A conventional loan is a mortgage offered and backed by private sector lenders, unlike government-insured loans, which are supported by federal agencies such as the FHA, VA, and USDA.

Conventional mortgages are provided by various types of lenders, including banks, credit unions, and online mortgage companies. They generally come in two main varieties:

  • Fixed-Rate Mortgages: Your interest rate remains constant throughout the life of the loan, resulting in consistent monthly payments of principal and interest.
  • Adjustable-Rate Mortgages (ARMs): These loans start with a fixed introductory rate for an initial period, typically three to ten years. After this period, the interest rate adjusts at regular intervals, such as annually or semi-annually, based on an index rate plus a margin set by the lender.

Conventional loan requirements

To get approved for a mortgage, you’ll need to meet the lender’s financial requirements, which generally include your credit score, income, and debt levels. Conventional loans often have stricter requirements compared to government-backed loans. Key qualifications include:

  • Credit Score: A minimum score of 620 is typically required for a conventional loan. Higher scores can improve your chances of securing better interest rates and terms.
  • Debt-to-Income (DTI) Ratio: This ratio includes all your monthly debt payments, such as auto loans, student loans, and credit card debt. Most lenders prefer a DTI ratio of 43 to 45 percent or lower.
  • Down Payment: While a 20 percent down payment is standard, many conventional loans for primary residences allow for down payments as low as 3 percent or 5 percent.
  • Private Mortgage Insurance (PMI): If your down payment is less than 20 percent, you’ll need to pay PMI. This fee is typically 0.46 percent to 1.5 percent of the loan amount each month, according to the Urban Institute.
  • Loan Size: Conventional loans are often conforming loans, meaning they adhere to Federal Housing Finance Agency (FHFA) limits on borrowing amounts. For 2024, the limit is $766,550 in most areas of the U.S. In higher-priced regions like parts of California and states such as Alaska and Hawaii, the limit can be up to $1,149,825.

Types of conventional loans

Conforming loans

Conforming loans adhere to the Federal Housing Finance Agency (FHFA) limits, allowing them to be purchased by Fannie Mae and Freddie Mac in the secondary mortgage market. When lenders sell these loans to Fannie Mae or Freddie Mac, they free up capital to issue more mortgages.

While all conforming loans are conventional loans, not all conventional loans are conforming. For instance, a jumbo loan—a mortgage that exceeds FHFA limits—is a conventional loan but not a conforming loan.

Jumbo loans

Jumbo loans exceed the FHFA’s conforming limits and cannot be sold to Fannie Mae or Freddie Mac. These nonconforming loans are available to qualified borrowers seeking more flexible financing options. Typically, jumbo loan rates are higher than those for conforming loans, though the difference has diminished in recent years.

Non-qualified mortgages

Non-qualified mortgages (non-QM loans) cannot be purchased by Fannie Mae or Freddie Mac either. These loans are an option for borrowers who might struggle to meet traditional credit or debt-to-income (DTI) requirements. Non-QM loans often cater to borrowers who do not fit the “ability to repay” criteria set by the Consumer Financial Protection Bureau after the 2008 financial crisis.

One example of a non-QM loan is a portfolio loan. In this case, the lender retains the mortgage rather than selling it, allowing for more flexible qualification criteria. However, non-QM loans often come with higher interest rates compared to conforming loans.

Subprime loans

Subprime loans are designed for borrowers with lower credit scores, typically below 600, who may not qualify for conventional mortgages. These loans generally come with higher interest rates and larger down payment requirements compared to conventional loans to offset the increased risk for lenders.

Adjustable-rate loans

Unlike fixed-rate loans, which maintain the same interest rate and monthly payment throughout the loan term, adjustable-rate mortgages (ARMs) begin with a lower introductory “teaser” rate. After this initial period, the interest rate adjusts periodically, causing monthly payments to fluctuate.

Amortized conventional loans

Amortized loans feature regular, fixed payments that cover both principal and interest, gradually reducing the loan balance to zero. Although the total monthly payment remains constant, the portion applied to interest decreases over time while the portion applied to principal increases.

Conventional loans vs. government loans

Conventional vs. FHA loans

FHA loans, backed by the Federal Housing Administration, are designed for borrowers with less-than-perfect credit. However, they come with a notable drawback: mortgage insurance that cannot be removed unless you make a down payment of 10 percent or more. Even then, you’ll need to wait 11 years to cancel it (this applies to loans originated after 2013; older loans have different rules).

Conventional Loan

  • Down Payment: Minimum of 3%
  • Credit Score: Minimum of 620
  • Debt-to-Income (DTI) Ratio: Maximum of 45% (in most cases)
  • Mortgage Insurance: Can be canceled with 20% equity

FHA Loan

  • Down Payment: Minimum of 3.5% (580 credit score minimum) or 10% (500 credit score minimum)
  • Credit Score: Minimum of 580 with 3.5% down or 500 with 10% down
  • DTI Ratio: Maximum of 50%
  • Mortgage Insurance: Includes an upfront premium and annual premiums

Conventional vs. VA loans

VA loans, guaranteed by the U.S. Department of Veterans Affairs, are available to military service members, veterans, and their spouses. To secure this type of mortgage, you will need to obtain a certificate of eligibility from the VA.

Conventional Loan

  • Down Payment: Minimum of 3%
  • Credit Score: Minimum of 620
  • Mortgage Insurance: Can be canceled with 20% equity
  • Property Use: Can be used for second or vacation homes, investment properties, and rental properties

VA Loan

  • Down Payment: None required
  • Credit Score: Typically 620 or higher (varies by lender)
  • VA Funding Fee: Ranges from 0.5% to 3.3%
  • Property Use: Must be used for primary residences

Conventional vs. USDA loans

USDA loans, guaranteed by the U.S. Department of Agriculture, can be a great option if your annual income is below a certain threshold and you’re purchasing a home in an eligible area.

Conventional Loan

  • Down Payment: Minimum of 3%
  • Income Requirements: Open to anyone who qualifies, regardless of income
  • Mortgage Insurance: Can be canceled with 20% equity
  • Property Location: Can be located anywhere

USDA Loan

  • Down Payment: None required
  • Income Requirements: Available to low- to moderate-income borrowers (income limit is $90,300 in most counties)
  • Fees: 1% upfront guarantee fee and 0.35% annual fee
  • Property Location: Must be located in a USDA-approved area

Pros and cons of conventional loans

Pros

  • Cancellable Mortgage Insurance: With a conventional loan, you can cancel PMI once you reach 20 percent equity in your home, even with a small down payment. This means you won’t have to pay PMI for the entire loan term.
  • Flexible Repayment Timelines: Conventional loans often come with standard 15-year and 30-year terms. However, some lenders offer flexible-term loans, allowing you to choose repayment periods ranging from eight to 29 years.
  • More Financing and Property Types: Conventional loans can be used for second homes, investment properties, and even jumbo loans for larger amounts. This flexibility is a significant advantage over government-backed loans, which typically require the home to be your primary residence.

Cons

  • Rigid Requirements: Conventional loans generally require a minimum credit score of 620, with some lenders demanding even higher scores. If your credit is not up to par, you may need to work on improving it before you qualify. Additionally, lenders often enforce a 43 percent DTI ratio limit.
  • Scrutiny of Past Hardship: If you have a foreclosure in your history, you’ll face a longer waiting period to qualify for a conventional loan—seven years—compared to other loan types, which may only require a two- to three-year wait.
  • PMI Costs: While PMI can eventually be canceled, you’ll still need to pay these premiums if your down payment is less than 20 percent, resulting in higher monthly payments until you reach the required equity.

How to apply for a conventional loan

Here are the steps to follow to secure a conventional mortgage:

  • Check Your Credit: Review your credit report for any errors or missing information. Assess your credit score and take steps to improve it if needed, such as paying down existing debts.
  • Save for a Down Payment: Conventional loans typically require a minimum down payment of 3 percent. For a $300,000 mortgage, this amounts to $9,000. A larger down payment can help you secure a better mortgage rate.
  • Review Your Debt-to-Income (DTI) Ratio: Your DTI ratio measures how much of your income goes toward debt payments each month. A desirable DTI ratio is 36 percent or lower, though some lenders may accept up to 50 percent. Most lenders set a cap between 43 and 45 percent.
  • Gather Your Documents: Prepare to provide various documents to your lender to verify your financial situation. This typically includes a government-issued ID, pay stubs, W-2s, 1099s, bank statements, investment and retirement account statements, and gift letters if applicable.
  • Compare Mortgage Lenders: Obtain quotes from at least three different lenders to compare terms and find the best deal for your situation.
  • Get Preapproved: Before house hunting, get preapproved for a loan. This involves a credit check and submission of documentation related to your income, assets, and debts. Preapproval provides a preliminary agreement to loan you a specific amount.
  • Get an Offer Accepted: Find a home you want, make an offer, and secure a signed purchase agreement.
  • Go Through Underwriting: During this phase, your lender will review your application and supporting documents in detail. They may request additional information and will also arrange for a home appraisal.
  • Close on the House: On closing day, finalize your home purchase and mortgage, pay any closing costs, and receive the keys to your new home.