A homebuyer’s guide to conventional loans

If you’re getting ready to buy a home, there are several different types of home loans and mortgages you might consider. The most common is a conventional loan. 

Find out how conventional loans work, how to qualify for one and some potential pros and cons to consider. 

Key takeaways

  • Conventional loans are backed and serviced by private lenders like banks and credit unions instead of government programs.
  • There are two main types of conventional loans: conforming loans and nonconforming loans. Nonconforming loans are also called jumbo loans. 
  • Conventional loans may cost less and have stricter requirements for things like credit scores, debt-to-income (DTI) ratios and down payments than some government-backed loans. 
  • Generally, conventional loans require a down payment of at least 3%. And if a down payment is less than 20%, conventional loans require private mortgage insurance (PMI).

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What is a conventional loan?

Conventional loans are mortgages that are backed and serviced by private lenders like banks, credit unions and online mortgage lenders.

Government-backed loans, on the other hand, are mortgages that are backed by U.S. government agencies like the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA) and the Department of Agriculture (USDA).

The Consumer Financial Protection Bureau (CFPB) says that conventional loans may be less expensive than government-backed loans. But conventional loans may also have stricter eligibility requirements. And while conventional loans aren’t backed by government programs, they may be bought and guaranteed by a government-sponsored enterprise (GSE) like Fannie Mae or Freddie Mac. 

How do conventional loans work?

Conventional loans have either fixed or adjustable interest rates. The interest rate on a fixed-rate mortgage is set when the mortgage is taken out and typically won’t change over the life of the loan. But the rate on an adjustable-rate mortgage may fluctuate throughout the loan term. It’s more common for a conventional loan to have a fixed interest rate than an adjustable interest rate. 

The most common conventional loan term—the amount of time the borrower has to pay back the loan—is 30 years. But some lenders also offer more loan term options—15 or 20 years, for example.

Types of conventional loans

There are two types of conventional loans:

  • Conforming loans: These loans have a maximum amount that’s set by the Federal Housing Finance Agency, called conforming loan limits (CLLs). And they vary by location. GSEs can’t buy mortgages that exceed these limits. For 2023, the baseline CLL for a single-unit property across most of the U.S. is $726,200. 
  • Nonconforming loans: Also known as jumbo loans, these conventional loans exceed CLLs. Jumbo loans are typically geared toward people with high credit scores, low DTI ratios, high incomes and significant cash reserves. The CFPB also notes that there may be other kinds of nonconforming loans that don’t fit in other loan categories. 

Conventional loan requirements

Here are a few conventional loan eligibility criteria to know about:

Credit score

There isn’t one credit score needed to buy a house. But generally, buyers using conventional loans may need a credit score of at least 620. An applicant’s credit score can also impact the interest rate they’re offered. And a higher credit score may help secure a lower rate. 

Down payment

Conventional loans typically require a down payment of at least 3%. First-time homebuyers and other qualified buyers may qualify for down payment assistance. Mortgages for second homes may require higher down payments, typically of at least 10%. Keep in mind that the amount of the down payment can also impact the interest rate. 

DTI ratio

DTI ratio is a snapshot of how much of your monthly income goes toward debt payments. This includes auto loans, student loans, credit card payments and more. 

Some conventional mortgage lenders may require borrowers to have a DTI ratio of 43% or less. But the CFPB recommends keeping your DTI ratio below 36%.

PMI

If you make a down payment that’s less than 20%, you’ll typically be required to pay PMI. PMI protects the lender if the borrower stops making their mortgage payments. It can generally be removed once the borrower has 20% equity in the home.

Conventional loan pros and cons

Before taking out any kind of loan, it’s important to think through all the potential pros and cons. You may consider talking to a qualified financial planner for help too. 

Pros

Some of the possible advantages of a conventional mortgage include:

  • Cost: Conventional loans may cost less than some other kinds of mortgages, according to the CFPB. That’s partly because conventional loans may have lower interest rates. But the interest rate a borrower is offered depends on many factors, including the lender, the borrower’s credit score, the down payment amount and more. 
  • Flexibility: Conventional loans may offer more flexibility than government-backed loans. Some private lenders offer more options when it comes to loan terms. And some government-backed mortgages may require the owner to use the property as their primary residence. But conventional mortgages can be used to finance things like second homes and investment properties. Plus, because of jumbo loans, homebuyers may be able to use a conventional loan to finance a high-cost property. 

Cons

Here are a few things to consider about conventional loans: 

  • PMI: You’ll need to pay PMI on a conventional loan if your down payment is less than 20%. But keep in mind that conventional loans aren’t the only type of mortgage that requires insurance. FHA loans require all borrowers to pay another kind of mortgage insurance called a mortgage insurance premium regardless of down payment size. 
  • Stricter requirements: Conventional loans may have more rigid requirements for things like credit scores and DTI ratios than some government-backed loans.
  • Foreclosure waiting period: If a potential homebuyer has a foreclosure on their credit report, they may have to wait seven years before they can get a conventional loan. Government-backed loans typically have shorter foreclosure waiting periods of two to three years. 

Conventional loans in a nutshell

Conventional loans are backed by private lenders instead of government agencies like the FHA, VA or USDA. Conventional loans may be less costly and have stricter eligibility requirements than some government-backed loans. 

Before you start shopping for a home, make sure you know all the important questions to ask when buying a house.

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