What Is a Conventional Loan?

Conventional loans are mortgages offered by private lenders, banks, and institutions that are not backed by the government. Unlike FHA, USDA, or VA loans, which are government programs, conventional loans usually require a larger down payment and better credit scores to qualify.

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Types of Conventional Loans

Conventional loan rates and terms vary based on the lender you choose to borrow from, however there are two basic categories: conforming and non-conforming.

Conforming

Unlike typical mortgage loans, conforming loans are regulated by Fannie Mae and Freddie Mac. These two mortgage investing companies were created by the federal government to generate stability and liquidity in the U.S. housing market.

Both Fannie Mae and Freddie Mac place restrictions on the amount of money you can borrow and on the property’s eligibility for the loan. In 2022, for example, the conforming conventional loan limit for an Illinois single-family loan is $647,200.

Non-Conforming

Alluding to its name, non-conforming loans fall outside of Fannie Mae and Freddie Mac’s restrictions. There are several types of non-conforming loans, including government-backed loans and portfolio loans.

• Government-backed options include the FHA, VA, and USDA loans. These loans have unique benefits and advantages that incentivize and support home-buyers.
• Other non-conforming loans are decided on by private lenders willing to grant loans that don’t fall Fannie Mae or Freddie Mac regulations. These loans might exceed the conventional loan limit (called jumbo loans) or allow borrowers to get a mortgage for a property that doesn’t meet conventional qualifications.

Government-backed loans have strict eligibility requirements. Other non-conforming loan options are determined by private lenders and vary based on their risk tolerance and on your financial history.

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Qualifications for Conventional Loans

Since the housing crisis in 2008, lenders have tightened restrictions on qualifying for conventional loans. Here’s how to qualify for a conventional loan:

Credit Score

You will most likely need a credit score of at least 620 to qualify for a conventional loan. The better your credit (often at 740 or higher), the less money you’ll have to put down.

What Is the Minimum Down Payment on a Conventional Loan?

The minimum down payment requirement for conventional loans is around 5%, but it can be as high as 20%. Down payment requirements vary based on your financial history and the type of property you want to buy. If you’re buying a second home or a property with more than one unit, for example, your down payment will be higher.

Does a Conventional Loan Require PMI (Private Mortgage Insurance)?

If you put down less than 20% as a down payment, you’ll be paying private mortgage insurance, which protects the lender if you default on your loan. PMI rates vary from .55% to 2.25% of the total home cost but take your credit and financial history into consideration as well.

Debt-to-Income

To ensure that you can make your monthly mortgage payments, lenders look for a maximum debt-to-income (DTI) ratio. However, while there is no guarantee a particular DTI percentage will be approved, for conventional loans DTI can never be more than 50%.

This means your total debt can only ever be half the amount of your total income or less.

Documentation

• Proof of Income: A lender will ask to see all the necessary documents to show your financial health and history. This includes pay stubs, tax documents, proof of income and assets, and employment verification. This documentation helps them determine the risk associated with lending you money, demonstrates your debt-to-income ratio, and verifies that you can pay for a down payment and closing costs.
• Credit and Background checks: Prepare to have documents on hand necessary for credit and background checks, including your driver’s license, Social Security number, and other forms of identification.

Conventional Loan Rates

Conventional loan interest rates change every day, but they are consistently lower than interest rates for FHA loans. Additionally for these loans, lenders determine your interest rates based on your credit history and financial situation.

How Long Does It Take to Close on a House With a Conventional Loan?

On average, it takes between 35 and 47 days to close on a house with a conventional loan. Keep in mind that closing times vary depending on other factors like price negotiation and inspections conducted by the buyer and lending company.

Benefits of Conventional Loans

Choosing a conventional loan depends primarily on your financial situation and the type of property you want to buy. Here are some of the key benefits to consider: 

Mortgage Insurance Control

Conventional loans can allow you to avoid the additional monthly PMI costs. This can happen by making a down payment greater than 20% or by asking your lender to remove PMI once 20% of your home is paid for. By contrast, the FHA loan requires mortgage insurance throughout the entire duration of the loan. If you want to get out of mortgage insurance, you will have to refinance out of the FHA loan, which will cost thousands of dollars in fees.

Choice of Loan Terms

The most common loan terms are for either 15 or 30 years for both conventional and government-backed options. However, if you’re taking out a conventional loan, lenders might consider alternate terms, such as 10-year or 20-year loans. 

Property Types

Conventional loans are available for property types that aren’t covered by other loan options, such as vacation homes or for major property repairs.

We wrote a whole blog to explain all the different types of mortgage loans available, read about them now!

Conventional Loans vs. Government Loans

Whether you choose a conventional or government-backed loan depends on what works best for you. While conventional loans offer more variety in loan terms and property types, each government option has unique benefits to consider.

Conventional vs. FHA: Which Is Better?

While conventional down payment requirements run as low as 3%, that rate is only offered to borrowers with excellent credit scores and large savings. The FHA loan allows a 3.5% down payment to buyers with lower credit scores.

One drawback to the FHA is the mandatory mortgage insurance that lasts the lifetime of the loan. With a conventional loan, you can avoid PMI by putting 20% or opt out of it once you have substantial equity in the property.

Conventional vs. VA Loans for Veterans

VA loans are offered to veterans and active-duty military by the U.S. Department of Veteran Affairs. Even if you qualify, a VA loan only applies to property that will serve as your primary residence. Unfortunately, this means you can’t use it for a vacation home or investment property.

However, one benefit to the VA loan is that it doesn’t require mortgage insurance. Although there is a VA funding fee required before closing, you’ll save money compared with the PMI payments on conventional loans.

Considering Conventional vs. USDA Loan

The USDA offers loans that come with low interest rates and don’t require a down payment. However, they only apply to designated properties in “rural” areas and don’t cover second homes. If you fall in a low or moderate-income bracket, the USDA loan can offer you lower payments than conventional loans on a property you plan to use as your primary residence.

Our Mortgage Learning Center features blogs on a wide range of mortgage and refinancing topics.

Choosing a Conventional Loan

Conventional loans require higher credit scores and a higher down payment than government-backed options like the FHA or VA loan. However, conventional loans allow you to opt out of mortgage insurance and it has more leniency on property eligibility. If you’re willing to make a higher down payment, the conventional loan offers you a higher degree of flexibility for your loan terms and financial planning.

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This page last updated: October 11, 2022