What Is a Conventional Loan? Benefits, Requirements and More

When you buy a home, you'll likely need a mortgage to finance the purchase. There are multiple types of loans that you could use, and deciding which is best could seem overwhelming. In this guide, we'll discuss conventional loans and how they stack up to other types of mortgages. 

A conventional loan is any mortgage that a government agency doesn't back. This means that if a borrower defaults, the government will not pay off the loan. Conventional loans are issued and insured by private lending institutions, such as banks and credit unions. 

A conventional loan can be classified as conforming or non-conforming. 

• Conforming loans must be less than the maximum loan amount set by the Federal Housing Finance Agency (FHFA) and meet the loan standards set by Fannie Mae and Freddie Mac. 
• Non-conforming loans do not comply with FHFA or Fannie Mae and Freddie Mac regulations. The most common non-conforming conventional loan is a jumbo mortgage.

Conventional home loans come in different forms, ranging from a standard fixed-rate mortgage to financing options tailored to unique situations.

A fixed-rate home loan is the most common conventional mortgage. Your interest rate is locked in with this type of mortgage, and it will remain the same for the entire life of the loan. Your principal and interest payments will stay the same every month with a fixed-rate loan.

An adjustable-rate mortgage (ARM) has an interest rate that changes over time. Most ARMs offer a low introductory rate during the initial fixed-rate phase, which typically lasts three to 10 years. After that, the interest rate will vary based on the index rate (the interest rate that lenders use for ARMs) and any additional percentage points outlined in your loan.

A jumbo loan is used when the mortgage balance exceeds the maximum amount allowed for a conforming home loan. For 2024, the conforming loan limit is $766,550 in most of the U.S.

A portfolio loan is a conventional loan that a lender keeps instead of putting it up for sale on the secondary mortgage market. Buyers who do not qualify for a standard conventional loan may be able to take advantage of a portfolio loan. The downside is that this type of non-conforming loan may have a higher interest rate and require more money for your down payment and closing costs. 

A subprime loan is designed for homebuyers who do not qualify for a loan that carries the prime interest rate (the rate lenders provide to the most creditworthy individuals). These non-conforming loans are designed for buyers with a low credit score, or those who are seen as a risk who may default on a loan. Subprime loans have higher interest rates, and the rate can vary among lenders. If you want a subprime loan, it's wise to shop with multiple mortgage lenders.    

As with any mortgage, you must meet specific requirements to be approved for a conventional loan. Every lender is slightly different, but you should meet these prerequisites. 

• Credit score: To qualify for a conventional loan, you'll usually need a minimum credit score of 620.
• Down payment: The amount you'll need to put down for a home loan varies. Some homebuyers can qualify with as little as 3% down, though a jumbo loan will require at least 5%. If you put down less than  20% on a conventional loan, you must pay for private mortgage insurance (PMI). 
• Private mortgage insurance (PMI): PMI protects mortgage investors in the case of a defaulted loan. You'll have to pay PMI if you put down less than 20%. The cost of PMI varies and is usually paid as part of your monthly mortgage payment.  PMI won't be on your loan forever. It will drop off when you have paid more than 20% of the balance on your loan.
• Debt-to-income ratio (DTI): Your debt-to-income ratio compares monthly expenses and earnings. It is determined by dividing your monthly debts (such as car payments, credit cards and rent) by your monthly pre-tax income. A DTI of no more than 45% is typically required for a conventional loan. Some lenders will accept a DTI as high as 50%, and most view a DTI of 36% as favorable. 
• Conforming loan limits: This refers to the maximum amount an individual can borrow for a conventional conforming loan. The maximum amount for 2024 is $766,550 in most areas of the country. In high-cost areas, the maximum is $1,149,825. 

A conventional mortgage is the right choice for a vast number of homebuyers. Still, they can have a few disadvantages if you’re building your credit or qualify for certain government-insured home loans. 

1. Flexible loan terms: Conventional loans have a variety of loan terms. Fixed-rate mortgages, for example, are offered with terms lasting for 10, 15, 20 and 30 years. Non-conventional loans are usually only offered with 15- or 30-year terms. 
2. No upfront mortgage insurance premium: Mortgage insurance premium (MIP) is a type of mortgage insurance required of all homebuyers who take out an FHA loan. You do not have to pay this premium with a conventional home loan. MIP is separate from PMI, which is only required if your down payment is less than 20% of the home’s purchase price. 
3. Higher loan limits: Conventional loans can have higher loan limits than government-backed loans. For example, the FHA loan limit in most areas of the country is $498,257, while the typical limit on a conventional conforming loan is $766,550.

1. Stricter qualification criteria: Since conventional loans come with higher risks, lenders are pickier about who they loan to. Compared with an FHA loan, you'll need a better credit score and a lower DTI to obtain a conventional mortgage. 
2. Higher down payment for some borrowers: Borrowers who want to finance with a jumbo mortgage or a portfolio loan may need to bring more money to the table. Buyers who qualify for VA and USDA loans may also be able to purchase a home with no money down.
3. Some conventional loans have higher interest rates: In some instances, an FHA loan may carry a better interest rate. Additionally, borrowers who seek conventional subprime and portfolio loans are more likely to deal with higher interest rates. 

Deciding between a conventional loan and a government-backed mortgage can be difficult. Work with a real estate agent who understands your needs and budget. They can guide you through the homebuying process, and help you find a property that meets your qualifications.

Loans backed by the Federal Housing Administration (FHA) are among the most popular government-insured loans. But is a conventional mortgage better than an FHA home loan?

"In many cases the terms for a conventional loan are more favorable than FHA in terms of closing costs and ongoing fees," says Sarah Alvarez, vice president of mortgage banking at William Raveis Mortgage. "For example, if you are making less than 20% down payment and require mortgage insurance – with the FHA product, there is an upfront mortgage insurance fee, which is added to the loan amount in addition to a monthly payment; that payment will never drop off of an FHA loan. With a conventional mortgage, when your equity in the home reaches 78%, the mortgage insurance automatically drops off."

Some of the most significant differences between a conventional mortgage and an FHA loan: 

• Credit score: You typically need a 620 credit score to qualify for most conventional loans. FHA loans are more flexible in this regard. In some instances, you can qualify for an FHA loan with a credit score of 500.  
• Down payment: The minimum down payment for a conventional mortgage starts at 3%. For an FHA loan, the required down payment will depend on your credit score. Most lenders will accept a 3.5% down payment if your credit score is 580. You can qualify for an FHA loan with a credit score of 500 if you put 10% down. 
• Debt-to-income ratio: FHA loans are more flexible if you have additional debt. The maximum allowed DTI with an FHA loan is 57%, but the lenders that issue these loans can set stricter requirements. 
• Property type: A conventional loan can be used to finance a primary or secondary home, as well as an investment property. You can only use an FHA loan to purchase a primary residence. 
• Additional fees: All homebuyers who take out an FHA loan must pay mortgage insurance premiums (MIP). Private mortgage insurance (PMI) is needed for both loan types if your down payment is less than 20%. 
• Interest rates: Your credit score and the lender you choose both impact your interest rate, but FHA loans carry rates that are more favorable in some cases.  

Loans backed by the U.S. Department of Veterans Affairs (VA) are only available to active-duty service members and veterans. If you're a veteran's surviving spouse, you may also be eligible. 

Aside from eligibility, the differences between VA and conventional loans include: 

• Credit score: Like a conventional mortgage, a VA loan typically requires a credit score of 620 to qualify. If your credit score is at least 580, some lenders may approve your loan with stricter requirements. 
• Down payment: You are not required to put anything down with a VA loan, but conventional loans require a down payment of at least 3%. 
• Debt-to-income ratio: A DTI of 41% or lower is preferred, so VA loans may be a bit less flexible than a conventional loan. 
• Private mortgage insurance: Unlike conventional loans, a VA loan does not require paying PMI if your down payment is less than 20% of the purchase price. 
• Property type: You can only use a VA loan to purchase a primary residence. Conventional loans can be used for a primary residence, second home or investment property.  
• Interest rates: While interest rates are based on various factors, VA rates tend to be lower than conventional rates. 
• Additional fees: VA loans require the payment of a VA funding fee and loan origination fees. 

Homebuyers might choose a U.S. Department of Agriculture (USDA) loan if they buy a home in a rural area. They differ from conventional loans due to the following factors: 

• Property type: With a USDA loan, you can only purchase a primary residence in eligible rural areas. 
• Income limits: Your household income cannot exceed a certain threshold with USDA financing. The income maximum varies by location, but the typical limit for 2024 is $110,650 for up to a four-person household. For households with five to eight people, the average limit is $146,050.
• Credit score requirements: USDA does not specify a credit score requirement, but most lenders require a credit score of at least 620. 
• Down payment requirements: USDA loans don’t require a down payment. 
• Debt-to-income ratio: A DTI of 41% or lower is preferred with USDA loans. 
• Private mortgage insurance: A USDA loan does not require you to pay PMI if your down payment is less than 20%. 
• Interest rates: In many cases, USDA loans have lower interest rates than conventional loans. 

Here's a look at the documents, and the criteria you will need to meet, when you apply for a conventional loan: 

To qualify for a conventional mortgage, you'll need to provide documentation that confirms your income and assets, as well as identification and tax information.  

• Identification: A driver's license, passport or other government-issued ID is required. Some lenders may request a copy of your Social Security card. 
• Proof of income: It's common for lenders to request two recent pay stubs and a W-2 form from your employer. Additionally, most lenders will request copies of your tax returns to confirm your income.
• Asset details: You must provide copies of statements from savings, checking and investment accounts, and retirement accounts such as a 401(k) or IRA.
• Debt information: A lender will want the details on all of your existing debt, including student loans, auto loans, credit cards and mortgages.

Generally, you'll need a credit score of at least 620 to qualify for a conventional loan. A higher credit score can provide additional benefits, including better interest rates and lower PMI costs. 

Here are a few strategies to improve your credit score: 

• Pay down your debt on revolving account balances. 
• Dispute errors on your credit report. 
• Make payments toward your bills and debts on time.
• Avoid applying for new lines of credit.
• Request a credit limit increase. 

A lender will typically want to see at least two years of consistent income when you apply for a conventional loan. Your income sources will be verified with bank statements, pay stubs, tax returns and W-2s. 

If you're self-employed, expect to provide your lender with two years of business and personal income tax returns. 

The types of income you can use to qualify for a conventional loan include your salary, bonuses, commissions and overtime, as well as income from contract, freelance and part-time work. Additional sources of income that a lender will consider include alimony and child support, as well as income from retirement accounts and Social Security. 

What does a conventional loan mean?  A conventional loan is any home loan that isn't backed by a government agency. Instead, this type of loan is issued and insured by private lending institutions, such as banks and credit unions.

Is a conventional loan good or bad?  Conventional loans are typically the best option for borrowers with good credit and the ability to make a down payment of at least 3%. The ideal borrower for a conventional mortgage has a credit score of at least 620 and a debt-to-income ratio of 36% or less. 

Which is better, an FHA or a conventional loan? A conventional loan is the best choice for homebuyers with a strong credit score and a larger budget. However, an FHA loan is likely better if your credit score is below 620. The interest rates offered with FHA loans can be more favorable if you need to build your credit.

Why would someone only take a conventional loan? Conventional loans may offer slightly lower down payment requirements than an FHA loan and do not require the borrower to pay mortgage insurance premium (MIP). They also provide the flexibility to secure financing on a second home or investment property; most other loans can only be taken out on a primary residence.