What Is a Conventional Loan?

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A conventional mortgage is a type of mortgage that isn’t backed by any government entities. It’s also the most common type of mortgage, accounting for about 80% of all mortgages closed as of March 2020, according to Ellie Mae

Conventional mortgages typically require higher down payments and credit scores than government-backed programs like an FHA or USDA loan. They may come with higher interest rates and fees for those who don’t have the best credit or lots of cash to put down. That was especially true during the pandemic when many lenders tightened requirements for borrowers. The good news is that it looks like lenders are starting to relax their requirements. 

Still, some borrowers may be better off with government-backed mortgages, which tend to have more flexible credit and down payment requirements. One type of mortgage is not necessarily better than the other – it depends on your individual situation, says Walda Yon, chief housing programs officer at the Washington D.C. based Latino Economic Development Center.

If you have a solid credit score and can qualify for a low-rate loan, now may be a good time to take out a conventional mortgage. 

How Conventional Loans Work

With a conventional loan, a borrower submits an application through a lender and is approved or denied based on a few key factors, including: 

  • Credit history
  • Credit score
  • Income
  • Employment
  • Down payment amount 
  • Debt-to-income ratio 

From there, if you’re approved, the lender will kick off the underwriting process and borrowers will go through a more rigorous round of vetting. It typically takes between 45 to 60 days to close a conventional loan, from start to finish. 

What Are the Types of Conventional Loans?

Conventional mortgages fall into two main categories: Conforming loans and non-conforming loans.

Conforming loans

A conforming loan meets guidelines set by Fannie Mae and Freddie Mac. Fannie and Freddie are quasi-government agencies set up to provide stability to the housing market by keeping mortgages affordable. They do this by purchasing mortgage loans from lenders. The lenders can then use that money to issue another mortgage.

Fannie and Freddie only purchase loans that meet certain standards. The guidelines for Fannie Mae and Freddie Mac are virtually the same, says Anna DeSimone, author of “Housing Finance 2020.” The main rule to be aware of is the FHFA conforming loan limits, which all Fannie or Freddie loans must fall under. Conforming loan limits vary by location and typically change each year. 

In 2021, the Federal Housing Finance Agency (FHFA) upped the maximum conforming loan limit for a single-family home from $510,400 to $548,250 and from $765,600 to up to $822,375 in certain high cost areas.

Non-conforming loans

A non-conforming loan, also known as a jumbo mortgage, exceeds the FHFA loan limits. Because Fannie Mae or Freddie Mac won’t purchase these loans, they are more risky for the lender and therefore harder to qualify for. To be eligible for a jumbo loan, you’ll need a higher credit score, bigger down payment, and more cash on hand compared to other types of mortgages. These loans also typically have higher interest rates than conforming loans. 

Across the board, the pandemic caused lenders to tighten mortgage lending standards, and jumbo loans were particularly hard hit. But as home prices skyrocketed over the last year, demand for jumbo mortgages has grown and lenders are seemingly more willing to offer this product as the economy recovers. 

How Is a Conventional Loan Different From a Government-Backed Loan?

The biggest difference between conventional and government-backed loans is who actually “backs”, or secures, the loan. Conventional mortgages aren’t guaranteed by the government, which means lenders tend to be choosier when it comes to vetting applicants. Government-backed loans, on the other hand, are backed by government entities which are on the hook if borrowers miss payments. 

Since conventional mortgage lenders don’t have the promise of a government safety net should the borrower fail to make payments, they need to be certain that borrowers are going to repay on time. That translates to tougher restrictions like higher down payment and credit requirements and potentially higher interest rates. 

While government-backed loans tend to be available to those with lower credit scores who can’t afford big down payments, they may have their own restrictions. For example, they may only be available for homes purchased in specific areas or certain property types.

How To Qualify for a Conventional Loan

To qualify for a conventional loan, you’ll typically need a credit score of at least 620. Lenders will also review your employment history, income, debts, and cash reserves to be sure you have a good chance at being able to afford your new mortgage payment if they approve you. 

To strengthen your mortgage application, be sure to follow a few best practices. Do not apply for new credit or switch jobs within six months of applying for a mortgage. These can both be red flags to lenders that you’re not a stable applicant. 

It’s a myth that applying for loans with different lenders will hurt your chances of getting approved. In fact, this is one of the best ways to get a good deal on your mortgage rate. Lenders will negotiate their fees and rates to win your business and you’ll have more leverage if you can show prospective lenders the kinds of deals you’re finding elsewhere. 

Advantages of a Conventional Mortgage

One big advantage of a conventional mortgage is the borrower has much more flexibility in what property they can purchase compared to a government-backed loan. For example, FHA loans are only available for homes that meet the FHA’s minimum property requirements. Other government-secured mortgages have even more specific limitations. U.S. Department of Agriculture (USDA) mortgages are only available for properties in designated rural areas, and only qualifying veterans and their spouses are eligible for Department of Veterans Affairs (VA) mortgages

Conventional mortgages don’t have any of these sweeping limitations. You can even take out a conventional loan for an investment property or a vacation home. And conventional jumbo mortgages are your only option if you need to borrow more than the FHFA loan limits for your area.

Pro Tip

With a conventional mortgage you don’t need to pay for private mortgage insurance if you have a down payment of at least 20%.

Conventional loans can also have fewer fees than government-secured loans. If you have a down payment of 20% or more on a conventional mortgage, you won’t be required to pay what is known as private mortgage insurance (PMI). PMI typically costs anywhere from 0.5% to 2% of the loan amount each year. The median home price in the U.S. in 2021 is over $350,000, so PMI could easily cost hundreds of dollars per month.

Being able to avoid PMI with a conventional loan can add up to significant savings over a government-secured mortgage. And even if you can’t put 20% down upfront, you can usually get rid of PMI once you’ve built up at least 20% in equity. That’s not the case with most government-backed home loans. An FHA loan has an upfront mortgage insurance fee and you’ll pay a monthly mortgage insurance premium no matter how much you put down, says Thomas Bayles, senior vice president at Los Angeles-based mortgage broker Mortgage Capital Partners. 

An FHA loan’s monthly mortgage insurance premium is about 0.5% to 1% of the loan principal and the upfront mortgage insurance payment can be 1.75% of the loan amount. If you want to get rid of an FHA loan’s mortgage insurance, typically the only way to do it is to refinance to a conventional mortgage once you’ve built up enough equity.

A USDA mortgage has a similar mortgage insurance fee structure, requiring an upfront fee and a monthly premium. VA loans don’t require mortgage insurance, but instead charge an upfront funding fee that can cost 1.4% to 3.6% of the loan amount. If you can avoid PMI with a conventional mortgage, you won’t have to spend thousands in unnecessary fees.

Drawbacks of a Conventional Mortgage

Conventional loans may be more popular, but that doesn’t mean they’re for everybody. 

There is a catch to the benefits of a conventional mortgage: you need a rock-solid financial profile. If you have a pristine credit score of 760+ and enough saved up for a 20% down payment, then you can qualify for the best mortgage rates and avoid paying for PMI

But as your credit score and down payment decrease, your interest rate will go up. Your PMI premium can also increase with a lower credit score or smaller down payment.

It’s rare for conventional loan lenders to allow for low down payments and many require 5% to 20% down. This can be prohibitively expensive for first-time homebuyers that don’t have the proceeds from a current home sale to add to a down payment. 

Government-backed loans can be good options for first-time homebuyers because some of these programs, like USDA and VA loans, have no minimum down payment requirement. 

It’s also harder to qualify for a conventional mortgage if you have blemishes on your credit report. The FHA lending guidelines have always been more flexible, and they are more lenient about past financial challenges like bankruptcies, DeSimone says. And it’s the only loan available to people with credit scores as low as 500, if they put 10% down, she says. 

The FHA loan credit score requirement goes up to 580 with a 3.5% down payment, and VA loans and USDA loans don’t have minimum credit score requirements. For a conventional loan, credit score requirements typically start around 620-660.

The bottom line: If you’ve got a healthy cash cushion, solid credit, and want to purchase a home without any location restrictions, a conventional mortgage might be right for you. But if you’re looking for a flexible product that allows you to purchase a home with little money down and lackluster credit, you might want to pursue other options.