Conventional Loans

What Is A Conventional Loan?

​​A conventional mortgage loan does not come with any insurance or guarantee by the federal government. Most conventional mortgage loans, aka conventional mortgages, are “conforming.” This simply means they meet the requirements to be sold to Fannie Mae or Freddie Mac. 

Fannie Mae and Freddie Mac are government-sponsored enterprises that purchase mortgages from lenders and sell them to investors. This frees up lenders' funds to get more qualified buyers into homes.

Conventional mortgages can also be non-conforming, which means they don't meet Fannie Mae's or Freddie Mac's guidelines. One type of non-conforming conventional mortgage is a jumbo loan, which is a mortgage that exceeds conforming loan limits.

Because there are several different sets of guidelines that fall under the umbrella of “conventional loans,” there is no single set of requirements for borrowers. However, conventional loans generally have stricter credit requirements than government-backed loans like FHA loans. In most cases, you'll need a credit score of at least 620 and a debt-to-income ratio of 50% or less.

Conventional Loan Requirements

 

Down Payment

It is possible for first-time homebuyers to get a conventional mortgage with a down payment as low as 3%. However, the down payment requirement may vary based on your personal situation and the type of loan or property you are getting:

  • If you're not a first-time homebuyer or making not more than 80% of the median income in your area, the down payment requirement is 5%.

  • If the home you’re buying is not a single-family home (i.e., it has more than one unit), you may need to put down 15%.

  • If you’re buying a second home, you’ll need to put at least 10% down.

  • If you’re getting an adjustable-rate mortgage, the down payment requirement is 5%.

  • If you're getting a jumbo loan, the down payment requirement ranges from 20% – to 40%.

In the case of refinancing, you will need more than 3% equity. In all other scenarios, you will need at least 5% equity. If you are doing a cash-out refinance, you will need to leave at least 20% equity in the home. When refinancing a jumbo loan, you'll need 10.01 – 25% equity, depending on the loan amount.

A mortgage calculator can help you figure out how your down payment amount will affect your future monthly payments.

Private Mortgage Insurance

If you put down less than 20% on a conventional loan, you will have to pay for private mortgage insurance (PMI). PMI protects your lender in case you default on your loan. The cost for PMI varies based on your loan type, your credit score, and the size of your down payment.

PMI is usually paid as part of your monthly mortgage payment, but there are other ways to cover the cost as well. Some buyers pay it as an upfront fee. Others pay it in the form of a slightly higher interest rate. Choosing how to pay for PMI is a matter of running the numbers to figure out which option is the cheapest for you.

The nice thing about PMI is that it will not be part of your loan forever – that is, you will not have to refinance to get rid of it. When you reach 20% equity in the home on your regular mortgage payment schedule, you can ask your lender to remove the PMI from your mortgage payments.

If you reach 20% equity as a result of your home increasing in value, you can contact your lender for a new appraisal to recalculate your PMI requirement. Once you reach 22% equity in the home, your lender will automatically remove PMI from your loan.

 

Other Requirements

  • Credit score: In most cases, you’ll need a credit score of at least 620 to qualify for a conventional loan.

  • Debt-to-income ratio: Your debt-to-income ratio (DTI) is a percentage that represents how much of your monthly income goes to pay off debts. You can calculate your DTI by adding the minimum monthly payments on all your debts (like student loans, auto loans, and credit cards) and dividing it by your gross monthly income. For most conventional loans, your DTI must be 50% or lower.

  • Loan size: For a conforming conventional loan, your loan must fall within the loan limits set by Fannie Mae and Freddie Mac. The loan limit changes annually. In 2020, the limit was $510,400. In 2021, it's $548,250. There are exceptions, however. Alaska, Hawaii, and high-cost areas of the country have higher loan limits, ranging up to $822,375 for 2021. To see loan limits for your area, visit the Federal Housing Finance Agency website.

 

How Is A Conventional Mortgage Different Than Other Loan Types?

Let us take a look at how conventional loans compare to some other popular loan options.

Conventional Loans Vs. VA Loans

While conventional loans are available to anyone who can meet the requirements, VA loans are only available to veterans, active-duty military members, and surviving spouses.

The requirements for VA loans are similar to that of conventional loans. VA loans, however, come with a few extra benefits. First, VA loans do not require a down payment. Second, VA loans do not require you to pay mortgage insurance, regardless of how much money you put down.

If you are thinking about getting a VA loan instead of a conventional loan, here are a few things to consider:

  • You cannot use a VA loan to buy a second home. The Department of Veterans Affairs only guarantees a certain dollar amount for each borrower, so you typically can’t have more than one VA loan at a time.

  • You will have to pay a funding fee. The funding fee offsets the cost to taxpayers of getting the VA loan. Certain groups (surviving spouses, those on VA disability, and Purple Heart recipients serving in an active-duty capacity) are exempt from paying the funding fee, but most are required to pay it. The funding fee ranges from 1.25% to 3.3% of the loan amount and varies based on how much your down payment is, whether you are buying a home or refinancing, and which branch you served in.

Conventional Loans Vs. FHA Loans

Conventional loans have stricter credit requirements than FHA loans. FHA loans backed by the Federal Housing Administration offer the ability to get approved with a credit score as low as 580. It also allows you to make a minimum down payment of 3.5%. On the other hand, conventional loans offer a slightly smaller down payment (3%). It would be best if you had a credit score of at least 620 to qualify.

When you are deciding between a conventional loan and an FHA loan, it’s important to consider the cost of mortgage insurance. If you put less than 10% down on an FHA loan, you will have to pay a mortgage insurance premium for the life of your loan – regardless of how much equity you have. On the other hand, you will not have to pay private mortgage insurance on a conventional loan once you reach 20% equity.

Conventional Loans Vs. USDA Loans

While conventional loans are available in all areas of the country, USDA loans can only be used to purchase properties in qualifying rural areas. Those who qualify for a USDA loan may find it very affordable compared to other loan options.

There is no maximum income for a conventional loan, but USDA loans have income limits that vary based on the city and state where you are buying the home. When evaluating your eligibility for a USDA loan, your lender will consider the incomes of everyone in the household – not just the people on loan.

USDA loans don't require borrowers to pay private mortgage insurance (PMI), but they require borrowers to pay a guarantee fee, similar to PMI. If you pay it upfront, the fee is 1% of the total loan amount. You also have the option to pay the guarantee fee as part of your monthly payment. The guarantee fee is usually more affordable than PMI.