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Conventional Loans​

What is a Conventional Loan?

A conventional loan is a type of mortgage that is not insured or guaranteed by a government agency like the FHA (Federal Housing Administration), VA (Veterans Affairs), or USDA (United States Department of Agriculture). Instead, conventional loans are backed by private lenders, such as banks, credit unions, or mortgage companies, and they often conform to the standards set by Fannie Mae and Freddie Mac—the two government-sponsored enterprises (GSEs) that purchase and guarantee mortgages in the secondary market.

Conventional loans are the most common type of mortgage in the U.S. and are popular with borrowers who have good credit and stable financial histories.

Key Features of Conventional Loans

  1. Conforming and Non-Conforming Loans:
    • Conforming loans meet the guidelines set by Fannie Mae and Freddie Mac, including loan limits, down payment minimums, and borrower credit requirements. As of 2023, the conforming loan limit for a single-family home in most areas of the U.S. is $726,200, though it can be higher in high-cost regions.  Some lenders as of 10/01/2024 are allowing loan limits up to $802,650 in all counties.
    • Non-conforming loans (also called jumbo loans) exceed the conforming loan limits and may come with stricter qualification requirements or higher interest rates.
  2. Lower Interest Rates for Qualified Borrowers: Borrowers with good credit scores, a stable income, and a low debt-to-income ratio (DTI) can benefit from lower interest rates on conventional loans compared to government-backed mortgages.
  3. Down Payment Options: Conventional loans typically require a down payment of 3% to 20%, depending on the loan amount and borrower qualifications. A 20% down payment eliminates the need for private mortgage insurance (PMI), but lower down payments may still qualify if the borrower opts for PMI.
  4. Private Mortgage Insurance (PMI): If you make a down payment of less than 20%, you’ll likely need to pay for PMI, which protects the lender in case of default. PMI can be canceled once you’ve built 20% equity in the home, unlike government-backed loans, which often require mortgage insurance for the life of the loan.
  5. Credit Score Requirements: Conventional loans generally require a higher credit score than government-backed loans. Most lenders look for a minimum credit score of 620, though a higher score may help secure better terms, including lower interest rates.
  6. Flexible Loan Terms: Conventional loans offer flexible loan terms, typically with 15-year or 30-year fixed-rate mortgages or adjustable-rate mortgages (ARMs). The fixed-rate option provides stable monthly payments, while ARMs can offer lower initial rates but fluctuate over time.

Benefits of Conventional Loans

  • Lower Overall Costs: If you have a strong credit profile and make a larger down payment, conventional loans tend to be more cost-effective than government-backed loans due to lower interest rates and the ability to avoid long-term mortgage insurance.
  • No Upfront Mortgage Insurance Fees: Unlike FHA loans, which require an upfront mortgage insurance premium (MIP), conventional loans don’t have this additional cost. PMI can also be removed once you’ve reached 20% home equity.
  • Higher Loan Limits: While FHA loans are limited to certain amounts, conventional loans, particularly jumbo loans, offer higher limits, making them suitable for high-cost properties.
  • Flexibility in Property Types: Conventional loans can be used to finance a variety of property types, including primary residences, second homes, and investment properties, offering more options to borrowers.  Government backed loans such as FHA or VA require for you occupy the home.
  • No Government Restrictions: Unlike government-backed loans, conventional loans don’t have strict property eligibility requirements. This flexibility makes it easier for borrowers to purchase homes in areas that may not qualify for FHA, VA, or USDA financing.

Types of Conventional Loans

  1. Fixed-Rate Mortgages (FRM): These loans have an interest rate that remains constant throughout the life of the loan, making it ideal for borrowers who want predictable monthly payments. Most fixed-rate mortgages are available in terms of 15, 20, or 30 years.
  2. Adjustable-Rate Mortgages (ARM): ARMs typically offer lower initial interest rates compared to fixed-rate mortgages, but the rate adjusts periodically after an initial fixed period (e.g., 5/1 ARM where the rate is fixed for 5 years and adjusts annually thereafter). This option is ideal for borrowers who plan to sell or refinance before the adjustable period begins.
  3. Conventional 97 Loan: This is a low down payment option where borrowers can qualify with as little as a 3% down payment. However, private mortgage insurance (PMI) will be required until the borrower has at least 20% equity in the home.
  4. Jumbo Loans: These are non-conforming loans for high-cost properties that exceed the conforming loan limits. They often have stricter qualification requirements, such as higher credit scores and larger down payments.

Who is Eligible for a Conventional Loan?

Borrowers typically need to meet the following criteria to qualify for a conventional loan:

  1. Credit Score: A minimum credit score of 620 is required, though a score of 700 or higher can lead to better terms, including lower interest rates.
  2. Down Payment: A down payment of at least 3% to 20% is required, depending on the lender and the specific loan program. A larger down payment can eliminate the need for PMI and lead to better loan terms.
  3. Debt-to-Income Ratio (DTI): Lenders usually prefer a DTI ratio of 45% or lower, meaning your monthly debt payments should not exceed 45% of your gross monthly income.
  4. Employment and Income Verification: Lenders will review your employment history and verify that you have a stable income to support the loan payments.
  5. Property Requirements: The home must meet lender guidelines for value and condition. Conventional loans can be used for a variety of properties, including single-family homes, condos, and multi-unit properties.

How to Apply for a Conventional Loan

  1. Check Your Credit: Ensure your credit score is in good shape before applying, as this will significantly impact your loan terms.
  2. Choose a Lender: Shop around for a lender that offers competitive interest rates and terms for conventional loans. Compare offers to find the best option.
  3. Submit Documentation: You’ll need to provide documents such as W-2 forms, pay stubs, tax returns, and bank statements to verify your income, employment, and assets.
  4. Get Pre-Approved: A mortgage pre-approval can give you an idea of how much you can afford and make your home-buying process smoother.
  5. Finalize the Loan: Once you’ve found a home and your loan is approved, you’ll complete the underwriting process and close on the loan.

Conclusion

A conventional loan is a versatile and popular mortgage option for borrowers with solid credit and financial profiles. It offers competitive interest rates, flexible loan terms, and the potential to avoid mortgage insurance with a larger down payment. Whether you’re a first-time homebuyer or an experienced investor, a conventional loan provides various options to meet your mortgage needs.