In this article:
A conventional loan is a mortgage loan that's not backed by a government agency. While some government-backed loans provide unique benefits to homebuyers, conventional loans remain far and away the most common type of mortgage.
According to the National Association of Home Builders, conventional loans accounted for 78.5% of new home sales in the first quarter of 2022.
If you're thinking about buying a home, here's what you should know about conventional loans to get an idea of whether it's the right fit for you.
How a Conventional Mortgage Works
Conventional loans are originated, backed and serviced by private mortgage lenders like banks, credit unions and other financial institutions.
Conventional loans are broken down into conforming and nonconforming loans, depending on whether or not they conform to guidelines set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), the two government-backed mortgage companies that own many mortgages in the U.S.
Here are some general characteristics to know:
- Credit score requirement: It's possible to get approved for a conforming conventional loan with a credit score as low as 620, although some lenders may look for a score of 660 or better.
- Down payment requirement: You can find conventional mortgage loans with a down payment requirement as low as 3%, and some lenders have special programs that offer up to 100% financing. However, if you don't put down 20% or more, the lender typically requires you to pay private mortgage insurance.
- Loan amounts: Conforming conventional loans go as high as $647,200 for single-family homes in 2022 ($970,800 if you live in a designated high-cost area). If you want a bigger loan than that, you'll need a jumbo loan.
- Loan terms: Conventional loans are typically repaid over a 30-year term, but it's possible to qualify for a 15- or 20-year conventional mortgage loan.
- Interest rates: You can get a fixed-rate loan or an adjustable-rate loan. Your interest rate will largely depend on your credit score and overall credit history. The better your credit is, the less you'll pay in interest over the life of the loan.
How Is a Conventional Loan Different From a Government-Backed Loan?
Government-insured mortgage loans have special features that can make them a good fit for certain homebuyers. Here's a quick summary of each option and who might consider it:
- FHA loans: An FHA loan is open to applicants with credit scores as low as 500 if you have a 10% down payment, or 580 if you have a 3.5% down payment.
- VA loans: A VA loan doesn't require a down payment or mortgage insurance, but is designed only for select members of the military community, their spouses and other beneficiaries.
- USDA loans: USDA loans have no down payment requirement and can help low- to moderate-income homebuyers who want to purchase a home in an eligible rural area.
Note that while these loans are insured by various government agencies, it's private lenders that offer them to borrowers—the same lenders that also offer conventional loans.
If you're trying to decide between a conventional loan and a government-insured loan, the right one for you depends on your financial situation. While government-backed loans offer perks if you don't have great credit or a sizable down payment, qualifying for one is not always easy. Additionally, you may save more money with a conventional loan if you have good credit or can put more money down. Compare the different options and their benefits and drawbacks to find the right loan program for you.
What Are the Types of Conventional Loans?
There are several types of conventional loans that you may come across as you compare lenders and mortgage options. Here are some of the most common ones and how they work.
- Conforming conventional loans: Conforming conventional loans are loans that adhere to the standards set by Fannie Mae and Freddie Mac, including maximum loan amounts discussed above.
- Jumbo loans: Jumbo loans allow you to borrow more than the maximum lending limit for conforming loans. However, they typically require a higher credit score, lower debt-to-income ratio (DTI) and larger down payment.
- Portfolio loans: A portfolio loan is a conventional loan that a lender chooses to keep in its own portfolio rather than selling it on the secondary market. This option allows the lender to be more flexible than what the Fannie Mae and Freddie Mac standards allow, especially with credit scores and DTIs.
- Subprime loans: Conforming loans require that you have a DTI below 50% and a credit score of 620 or higher. But if your credit isn't quite there, you may qualify for a subprime mortgage loan.
- Amortized conventional loans: These loans are fully amortized, giving homebuyers a set monthly payment from the beginning to the end of the loan repayment period, without a balloon payment. Amortized conventional loans can have fixed or adjustable mortgage rates.
- Adjustable-rate loans: A fixed-rate mortgage loan has the same interest rate—and, therefore, the same monthly payment—throughout the life of the loan. With an adjustable-rate mortgage, however, you'll get a fixed interest rate for a set period, typically between three and 10 years. After that, your interest rate can adjust each year based on the current market rates.
What Are the Advantages of a Conventional Loan?
There's no right mortgage loan for everyone, so it's important to know both the benefits and drawbacks of each of your options before you choose. Here are some of the benefits you'll get from a conventional loan:
- Low costs: A high credit score can help you qualify for a low interest rate. Plus, you can request to have the insurance requirement removed once your loan-to-value ratio reaches 80%. In contrast, the mortgage insurance premium that comes with an FHA loan may remain for the life of the loan, and the same goes for the guarantee fee on a USDA loan.
- Higher loan limits: While conforming loans do have limits, you can go even higher with jumbo conventional loans if you need to. You may not get that kind of flexibility with government-insured loans.
- Flexibility for some: Private mortgage lenders have more flexibility with conventional loans than they do with government-insured loans, primarily because they don't need to follow the guidelines set by those government agencies.
What Are the Downsides of a Conventional Loan?
Along with some of the benefits of getting a conventional loan over a government-backed one, there are also some disadvantages to consider:
- Higher credit score requirements: You typically need credit scores of at least 620 to qualify for a conforming conventional loan, which is higher than what some government-backed loans require.
- Higher down payment requirements: Some conventional loan programs allow you to put down 3% or even nothing at all if you're a first-time homebuyer, but expect to pay 5% after that. In contrast, FHA loans require a minimum down payment of 3.5%, and USDA loans and VA loans have no down payment requirement at all.
- Stricter qualifying guidelines: Government-insured mortgage loans place less risk on the mortgage lender, so it may be easier to qualify for one of those, as long as you meet the agency's eligibility requirements. With a conventional loan, on the other hand, your personal financial situation may be scrutinized more closely because the lender is taking on more risk by originating the loan.
How to Qualify for a Conventional Loan
If you've decided that a conventional loan is right for you, here are steps to qualifying for one:
- Check your credit score. Before you do anything else, it's important to know where your credit stands. You can do this by checking your credit score for free with Experian. If your credit score is 620 or higher, you'll have a chance to get approved for a conforming conventional loan. And if it's in the mid- to upper-700s, you'll have a better chance of qualifying for favorable terms on your new loan.
- Save for a down payment. While many conventional loans don't require a big down payment, the more money you put down, the better your chances of qualifying for a lower interest rate.
- Check your debt-to-income ratio. In addition to reviewing your credit score, lenders will look at your DTI. Lenders typically want to see that your total monthly debts are no more than 36% of your monthly gross income. Lenders may stretch their required DTI to 43% or higher in some cases, but the maximum Fannie Mae and Freddie Mac will allow for conforming loans is 50%.
- Research mortgage lenders. Take some time to look at different mortgage lenders, including what rates they're offering, how the application process works and whether you can do it online. Try to find at least three to five lenders you like before applying.
- Get preapproved. A mortgage preapproval is a letter from a mortgage lender effectively agreeing to lend you up to a certain amount of money to buy a home, as long as you meet certain conditions. During this process, the lender or broker will let you know whether you need to make other changes to improve your eligibility to buy a home.
Once you have a preapproval letter in hand, start the house-hunting process. And keep in mind that you're not married to the mortgage lender that provided your preapproval letter. In fact, it's a good idea to apply with multiple lenders to compare rates and terms.
When you are shopping for the best rates and submit mortgage applications at several lenders, do so within a short time period—typically 15 to 45 days. That way the credit scoring models will roll those applications into one credit inquiry on your credit report, which minimizes damage to your credit score.
The mortgage process can take a long time from start to finish, but taking each step carefully can help you get the best deal for your situation.