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What is a conventional loan?

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When looking for mortgages to buy a home, you’ll encounter range of options, including conventional loans.

What is a conventional loan?

In short, a conventional loan is not guaranteed by the government. Instead, it’s available and guaranteed through the private sector. Conventional loans account for a large portion of purchases and refinances, and are available through different types of mortgage lenders, including banks, credit unions and online lenders.

Government-insured loans, by comparison, are backed by a government institution. These include FHA loansVA loans and USDA loans.

Conventional loans come in two main types: fixed-rate or adjustable-rate. With a fixed-rate mortgage, your interest rate never changes. With an adjustable-rate mortgage, the rate changes with market conditions at predetermined

Conventional loan requirements

To be approved for any type of mortgage, you’ll need to meet the loan’s requirements. Conventional loans tend to have stricter requirements than government-backed loans, such as:

Credit score

If you think about being approved for a conventional loan as a set of stairs, the first step would be your credit score. Mortgage lenders require a minimum score of 620 to qualify for a conventional loan — but that’s the minimum only. To secure the lowest interest rate and the best deal, you’ll want a much better score, generally 740 or higher.

Debt-to-income (DTI) ratio

Moving up those stairs, the next piece of information a lender will scrutinize is your debt-to-income (DTI) ratio. Your DTI ratio factors in other debts you have to pay each month, such as auto loans, student loans and credit card debt. Most lenders will not want this ratio to exceed 43 percent, although some might make an exception and allow up to 50 percent.

Down payment

Unlike some government-insured loans, a lender isn’t going to give you 100 percent of a home’s purchase price in a conventional loan — you’ll need to be able to make a down payment. Many fixed-rate conventional loans for a primary residence (not a second home or investment property) allow for a down payment as small as 3 percent or 5 percent. If you’re taking out a 3-percent down conventional loan to buy a house that costs $350,000, for example, you’ll need to put at least $10,500 down.

Private mortgage insurance

The ability to put down just 3 percent is an appealing benefit of conventional mortgages, but that small down payment comes with a drawback: private mortgage insurance (PMI). Because you didn’t make a 20 percent down payment, PMI helps protect the lender in case you default. So, until you accumulate 20 percent equity in the home — either by paying down your mortgage or upping your home’s value — you’ll need to pay the additional cost of PMI.

Loan size

The final step on the path toward a conventional loan is how much money you need to actually borrow. For conforming conventional loans, the Federal Housing Finance Agency (FHFA) sets limits each year. These vary based on where the property is located. In the majority of the U.S., the limit for 2021 is $548,250. Higher-priced areas like California and New York City have limits of $822,375. Anything larger, and you’ll be looking for a jumbo loan.

Conventional loan types

1. Conforming loans

Mortgages that fall within the FHFA’s limits are called conforming loans. This means that they are able to be bought by Fannie Mae and Freddie Mac, two government-sponsored enterprises (GSEs), through the secondary mortgage market. By selling these types of loans to Fannie Mae and Freddie Mac, lenders obtain the capital to continue to make new mortgages.

2. Jumbo loans

Mortgages that exceed conforming limits are called jumbo loans or nonconforming loans. These are loans that can’t be sold to Fannie or Freddie, but they are still available to well-qualified borrowers who need a more flexible conventional loan option.

“In order to get these larger loans, you usually need to show that you have the assets or income to justify it,” says Casey Fleming, branch manager with Fairway Independent Mortgage Corporation in Campbell, California, and author of “The Loan Guide: How to Get the Best Possible Mortgage.” “You might need a bigger down payment, and the credit requirements can be harder to meet.”

Additionally, jumbo loan rates tend to be higher than what you’d see with a smaller mortgage.

3. Non-qualified mortgages

Non-qualified mortgages, often described as non-QM loans on lenders’ websites, also cannot be purchased by Fannie or Freddie, but they can be an option for those who are able to afford a mortgage but maybe are unable to meet the credit or DTI requirements. These borrowers tend to fall outside of the “ability to repay” guidelines established after the 2008 financial crisis, which indicate whether a borrower is likely to repay a mortgage.

One type of non-QM loan could be a portfolio loan. With this kind of loan, a lender keeps the mortgage on its books, rather than sell it to Fannie or Freddie. Because it doesn’t have to meet conforming loan standards, the lender can be more flexible when qualifying a borrower. It’s important to note, though, that non-qualified mortgages often come with higher interest rates.

Advantages of a conventional loan

Why do so many borrowers choose conventional loans? They come with a few key upsides:

Cancellable mortgage insurance

One of the big pros of a conventional loan is that you won’t have to deal with paying for PMI for the duration of the mortgage. Once you have 20 percent equity in the home, you can request to cancel PMI. To compare, if you had a 30-year FHA loan and made a down payment of less than 10 percent, you’d be paying those insurance premiums for the full three decades (unless you sell the home or refinance into a conventional loan).

Flexible repayment timelines

When you’re browsing conventional loans, the most common loan terms you’ll find are 15-year and 30-year payback periods. However, some lenders have conventional loan programs, known as flexible-term or flex-term loans, that allow you to choose from a wider range of time frames, typically eight to 29 years.

More financing and property types

While government-backed mortgage programs tend to come with the owner-occupied requirement (in other words, you have to live in the home), conventional loans are available for second homes and investment properties. Plus, the fact that jumbo loans fall into the conventional loan bucket means that highly-qualified candidates can manage to borrow high sums of money.

Conventional loans vs. government loans

FHA loans — insured by the Federal Housing Administration — are ideal for borrowers with less-than-perfect credit, but they come with a less-than-ideal cost: mortgage insurance that cannot be removed.

Conventional vs. FHA loans

Conventional loan FHA loan
3% down payment minimum 3.5% down payment minimum
620 credit score minimum 580 credit score minimum with 3.5% down (500 credit score minimum with 10% down)
43% DTI maximum (in most cases) 50% DTI maximum
Can cancel mortgage insurance with 20% equity Mortgage insurance includes one-time premium upfront 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 eligible spouses. There are some additional steps to obtaining this type of mortgage, though, including getting your Certificate of Eligibility from the VA.

Conventional loan VA loan
3% down payment minimum No down payment required
620 credit score minimum 620 credit score or higher (depends on lender)
Can cancel mortgage insurance with 20% equity Must pay VA funding fee ranging from 1.4% to 3.6%
Can be used for second or vacation homes and investment or rental properties Can only be used for primary residences

Conventional vs. USDA loans

USDA loans — guaranteed by the U.S. Department of Agriculture— can be a viable option if your annual income doesn’t exceed a certain amount and you’re looking to buy a home in an area that meets USDA guidelines.

Conventional loan USDA loan
3% down payment minimum No down payment required
Available to anyone who qualifies, regardless of income Available to low- to moderate-income borrowers (in most counties, the income limit is $90,300)
Can cancel mortgage insurance with 20% equity Must pay 1% guarantee fee upfront and annual fees (currently 0.35%)
Property can be located anywhere Property must be located in a USDA-approved area

Conventional loan rates

Conventional mortgage rates are based on economic and market conditions as well as your lender’s overhead, and change daily. The rate you get will primarily be determined by your financial picture and the current economic environment. You’re most likely to get the best rates if you have good credit.

While rates for 30-year mortgages have hovered near 3 percent in the past year, they are beginning to rise. Recently, Freddie Mac predicted rates will increase to 3.8 percent by the end of 2022.

Bottom line

You have a lot of choices for a mortgage, but a conventional loan can be a wise choice for keeping costs low, and is one of the more popular options for borrowers.

The best way to qualify for a conventional loan is to have your credit, income and assets in order. Keep in mind that while some lenders are willing to be flexible, you usually need to compensate for a deficiency in one area when qualifying for a conventional loan. For example, if you have a lower credit score, you usually need a bigger down payment and higher income. Overall, if you can make a down payment, show adequate income and have a qualifying credit score, you’re likely to be able to get a loan.

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Written by
David McMillin
Contributing writer
David McMillin is a contributing writer for Bankrate and covers topics like credit cards, mortgages, banking, taxes and travel. David's goal is to help readers figure out how to save more and stress less.
Edited by
Mortgage editor
Reviewed by
Professor of finance, Creighton University