A conventional loan is one of the most popular types of mortgages used by homebuyers in the United States. These loans make up the majority of the mortgage market and are offered by private lenders like banks, credit unions, and mortgage companies.
What is a Conventional Mortgage?
A conventional mortgage or loan is simply a home loan that is not insured or guaranteed by the federal government. This sets it apart from government-backed loans like FHA loans, VA loans, and USDA loans.
Instead, conventional loans are underwritten according to the guidelines set by Fannie Mae and Freddie Mac, two government-sponsored enterprises. Loans that meet these guidelines are called “conforming loans.”
The main advantages of conventional mortgages include:
- More flexible guidelines than government loans
- Available for a wide range of borrowers and property types
- Lower mortgage insurance costs than FHA
- No program fees like VA or USDA loans
The main drawback is that conventional loans have stricter eligibility requirements compared to government programs. Applicants need good credit, stable income, and a substantial down payment.
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Conventional Loan Requirements
To qualify for a conventional mortgage, you’ll need to meet certain credit score, income, and down payment requirements. Each lender may have specific overlays, but in general you can expect to need:
- Credit score – Most lenders require a minimum credit score of 620 for conventional loans. The higher your score, the better interest rate you can qualify for. Ideal scores are 740 and above.
- Down payment – Conventional loans allow down payments as low as 3% of the purchase price. However, 20% down is preferred to avoid private mortgage insurance (PMI).
- Debt-to-income ratio – Your monthly debt payments, including the future mortgage, should not exceed 43% of your gross monthly income in most cases. Some lenders may allow up to 45%.
- Loan limits – For a conforming loan, the mortgage amount cannot exceed limits set by the FHFA. In 2023, the baseline conforming limit is $726,200 for single-family homes. Higher limits exist for certain high-cost areas.
- Homebuyer education – Completing an approved homebuyer education course may be required for first-time home buyers.
Meeting these requirements demonstrates to the lender that you’re financially stable enough to repay the mortgage. Those with lower credit scores or income may need to improve their profile or explore government-backed loans instead.
Types of Conventional Loans
Within the conventional loan category, there are a few main types of mortgages available:
Conforming Loans
Conforming loans are the most common type of conventional loan. They meet the underwriting guidelines set by Fannie Mae and Freddie Mac, including loan limits that vary by county. Because they can be purchased and securitized by the GSEs, conforming loans offer the best interest rates.
Nearly all lenders offer conforming loans with both fixed and adjustable interest rates. Common terms are 15-year or 30-year.
Jumbo Loans
A jumbo mortgage exceeds the conforming loan limits in your county, requiring a larger loan amount. For example, jumbos start above $726,200 in most areas. Jumbos are non-conforming but are still conventional loans offered by private lenders.
Because they cannot be purchased by Fannie Mae or Freddie Mac, jumbos usually have higher interest rates than conforming loans. Minimum credit scores and down payments are also higher. Jumbos appeal to luxury home buyers or those in high-cost markets.
Non-Qualified Mortgages
Non-QM or nonprime loans are unconventional mortgages made to borrowers who don’t qualify for “qualified mortgages” under Consumer Financial Protection Bureau guidelines. These include self-employed borrowers and those with past credit events like bankruptcy or foreclosure.
Rates are higher and requirements stricter on non-qualified mortgages due to increased risk to lenders. Alternative documentation like bank statements may be used to underwrite these loans.
Cash-Out Refinance
Borrowers who want to tap equity in their current home to get cash can do a cash-out refinance. This replaces your current mortgage with a higher-balance conventional loan, providing funds left over after paying off the old loan.
Cash-out refis require full underwriting and appraisal just like a purchase loan. Most lenders require a loan-to-value ratio of at least 20%.
Home Equity Loan/HELOC
Home equity loans and HELOCs allow homeowners to borrow against the equity in their property. The main difference is home equity installment loans have fixed payments and terms, while HELOCs operate as revolving lines of credit with variable rates.
Both should only be taken by homeowners who need funds for a specific purpose, like a home remodel. They involve paying origination fees and interest.
Conventional Loans vs. Government Loans
Government-backed loans through FHA, VA, and USDA involve some tradeoffs compared to conventional mortgages:
Conventional Loans
- Minimum 620 FICO score
- As low as 3% down payment
- No upfront program fees
- PMI removable at 20% equity
FHA Loans
- Minimum 580 FICO score
- 3.5% down payment
- Upfront MIP and monthly premiums
- PMI for life of loan
VA Loans
- No minimum FICO score
- No down payment required
- VA funding fee
- For veterans and service members only
USDA Loans
- No minimum credit score
- No down payment
- For rural/suburban locations only
- 1% upfront guarantee fee
While government loans offer benefits like low down payments and credit leniency, conventional loans provide quicker PMI cancelation and no recurring program fees. Conventional loans are also available to a broader segment of borrowers.
Ultimately, choosing between conventional and government-backed depends on your specific financial situation and goals.
How to Apply for a Conventional Mortgage
Follow these key steps when applying for a conventional home loan:
1. Check Credit Reports
Order free copies of your credit reports from AnnualCreditReport.com and review for errors. Dispute any inaccuracies with the bureaus. Also check your FICO credit scores.
2. Save for Down Payment
Aim to save at least 3% to 5% for a down payment if you want a conventional loan. Shop around with lenders to see offers. The more you put down, the better the terms you can qualify for.
3. Get Preapproved
Reach out to multiple lender to get preapproved. Being preapproved shows sellers you’re a serious buyer. Locking in your rate and terms early also prevents surprises.
4. Make an Offer
Once preapproved, you can confidently make an offer on a home you want to buy. Submit your offer with proof of your preapproval letter.
5. Complete Loan Application
Now you’ll need to complete a full loan application and provide documents so the lender can underwrite the mortgage. Be responsive to requests.
6. Final Underwriting
The lender will order an appraisal and issue a final approval of the loan. Make sure conditions are met. Shop for homeowners insurance.
7. Closing
At closing, you’ll finalize the transaction, sign loan documents, pay closing costs and receive the keys to your new home!
Get prequalified with multiple lenders early to compare mortgage rates and terms. This helps set you up for success through the rest of the home buying process.
The Bottom Line
Conventional mortgages are a great option for many homebuyers because of their competitive rates, low down payments, and flexible qualification guidelines. Just be sure to shop multiple lenders to find the best loan for your situation. Getting prequalified early in the home buying process can set you up for success.
Conventional Loan FAQs
What are the benefits of conventional loans?
Benefits include low down payments on par with government loans, no recurring MIP/funding fees, and the ability to cancel PMI once 20% equity is reached. Conventional loans are available from nearly all lenders too.
What credit score is needed for a conventional loan?
Most conventional loans require a minimum credit score of 620. But scores of 740+ will qualify you for the very best interest rates from lenders. Managing your credit diligently is key to getting approved.
Can you put less than 20 percent down on a conventional loan?
Yes, conventional loans allow down payments as low as 3% for buyers with good credit. However, less than 20% down means paying private mortgage insurance until you build 20% home equity.
How do I get rid of PMI on my conventional loan?
To cancel PMI, you’ll need to reach 20% equity in the home through your down payment, paying down the loan balance, or appreciation. Contact your lender to request PMI cancellation once you have 20% equity or more.
Can I get a conventional loan after a short sale or foreclosure?
Yes, but you’ll need to wait a period of 12-24 months after the event for your credit to recover before qualifying for a new purchase. Requirements vary by lender.
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