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A MoneyTips Guide to Conventional Loans

tl;dr

What You Need To Know

  • Conventional loans aren’t backed by the federal government. You can get one through a bank or online lender
  • Compared to government-backed loans, you’ll need a higher credit score and a strong financial history to get a conventional loan
  • Conventional loans are widely available and offer competitive interest rates and flexibility

Contents

If you’re shopping around for a mortgage, you’ll probably hear words like “conventional” and “conforming” and acronyms like “VA” and “FHA” thrown around by mortgage lenders and loan officers.

It can feel a bit overwhelming, but we’re here to translate.

With this helpful guide to conventional mortgage loans, you can shop for your mortgage without the stress.

What Is a Conventional Loan?

A conventional loan is a mortgage loan that you can get from most lenders, including banks, credit unions, other mortgage lenders and mortgage brokers. The mortgage loan is considered conventional because it isn’t backed by a federal agency like the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA) or the U.S. Department of Agriculture (USDA).

That means the loan is between you and your lender.

Uncle Sam doesn’t have a direct stake in the kinds of terms you’re offered and doesn’t have to worry about you making your monthly payments on time.

Conventional loans are the most common type of mortgage loan available.

Want to get a sense of how many loans in the U.S. are conventional and how many aren’t? According to the first-quarter census data for 2021, new home purchases were financed through:

  • Conventional mortgage loans: 72%
  • FHA loans: 19%
  • VA loans: 5%
  • Cash: 4%

Are There Different Types of Conventional Loans?

Yes. Conventional loans can be divided into two categories: conforming and nonconforming.

  • Conforming loans: Meet standards set by Fannie Mae and Freddie Mac
  • Nonconforming loans: Don’t meet standards set by Fannie, Freddie or Uncle Sam

It can be easy to get conventional and conforming loans mixed up, so let’s get two things clear:

  • When anyone talks about a conforming loan, they’re talking about a conventional loan.
  • The vast majority of available conventional loans are conforming loans.

Conforming loans meet specific standards set by Fannie Mae and Freddie Mac. Both are publicly traded companies that are managed by the Federal Housing Finance Agency (FHFA).

Fannie Mae and Freddie Mac aren’t regulators – and they can’t tell lenders what to do – but they have enormous power because they back trillions of dollars in mortgage loans.

Because conforming loans are financially backed by Fannie Mae and Freddie Mac, lenders prefer to offer them because they see them as less risky.

What Are the Benefits of a Conventional Loan?

While the use of government-backed loans (like the FHA loan) has grown since 2008, there are lots of reasons why conventional loans are more popular.

Higher borrowing limits

The lending limits for a conventional mortgage are usually higher than an FHA mortgage. In 2021, the FHA loan limit for most areas was $356,362 and the FHFA conventional mortgage limit was $548,250.

Flexible terms

While FHA loans tend to have 30- or 15-year terms, conventional mortgage loans allow greater flexibility with the length of the loan.

Borrowers can borrow for 10-, 20- or 25-year terms – as well as 15- and 30-year terms – if it fits their financial needs.

Mortgage insurance can be canceled

Conventional loans and FHA loans require mortgage insurance, but only conventional mortgages allow you to cancel private mortgage insurance (PMI) once you’ve reached at least 20% equity in your home.

Available for many property types 

A conventional mortgage can be used for many types of property, including second homes, vacation homes or rental properties.

One of the biggest limits of FHA and other government-backed loans is that they can only be used for a primary residence and certain types of properties that meet FHA requirements.

How Do I Get a Conventional Mortgage Loan?

Getting a conventional loan starts with submitting a mortgage application. You can apply through a local, brick-and-mortar bank, an online mortgage lender or a credit union.

No matter where you get your mortgage loan from, they’ll want to know that you meet the criteria.

Credit score

To qualify for a conventional loan, most conventional lenders require a credit score of 620 or higher. The better your credit score, the more favorable rates you’ll get.

Debt-to-income (DTI) ratio

Lenders will look at your DTI to see how much you owe compared to how much you earn. To qualify for a conventional loan, most lenders prefer a DTI of 50% or less, though some lenders may offer some flexibility.

Down payment

In the past, a 20% down payment was standard. 

With the growth of the housing market and lower interest rates on savings accounts, lenders are now willing to accept as little as 3% down.

Here’s the catch: If you pay less than 20% down, lenders are likely to charge you more in interest, and they’ll also want you to pay for private mortgage insurance (PMI).

Proof of income and employment

For a conventional loan, lenders will want to see that you earn enough to make your regular monthly payments. To confirm, they’ll want to see proof of income. Typically, they’ll request recent pay stubs and W-2 forms.

What Types of Conventional Loans Are Available?

Now that you understand what a conventional loan is, it’s time to look at the types of conventional loans that are out there.

Fixed-rate mortgage loans

Thanks to their long-term stability, these are the most popular types of conventional mortgage loans.

The interest rate for this loan stays the same over the life of the loan. You agree to borrow a certain amount of money and pay it back at a fixed interest rate over a fixed period of time. With this kind of loan, you always know what you’ll be paying each month.

Adjustable-rate mortgage loans

With an adjustable-rate mortgage, the interest rate is variable, which means it can go up or down over the life of the loan.

Adjustable-rate mortgages usually offer a lower-than-average interest rate for the first 3 – 10 years. After that, the rate adjusts based on terms you and your lender agreed to in advance.

As a home buyer, adjustable-rate mortgages can be advantageous if your credit makes it harder to get a good interest rate or you only plan to stay in your home for 3 – 10 years.

Super conforming mortgage loans

Freddie Mac created super conforming loans for borrowers who want to borrow more than the limits set by Fannie Mae and Freddie Mac and live in high-property-value areas.

As of 2021, super conforming loan limits for mortgages are $822,375 for one-unit properties and can go as high as $1,581,750 for a four-unit property.

Home renovation loans

If you’re buying a fixer-upper, these conventional loans can help you purchase a home and get the money you need to repair and renovate.

To make it easier to buy and renovate, try two programs:

These loans are not the same as government-backed FHA 203(k) loans.

What About Conventional Nonconforming Loans?

Wondering if you should consider this type of loan? Well, it depends.

These loans have benefits, like letting you borrow more money, but mortgage lenders have more power to set the terms and conditions.

Conventional vs. Jumbo loans

If you’re looking to buy big and you don’t qualify for a super conforming mortgage loan, you can talk to your lender about a jumbo loan.

These loans are often used to borrow over the conforming loan limits and usually require higher credit scores and a down payment of at least 20%.

Is a Conventional Loan My Best Option?

For most borrowers with decent credit, the answer is yes, but it depends on your individual situation and financial goals.

After the 2008 financial crisis, government-backed mortgage lending spiked. The number of lenders taking advantage of FHA and VA loans increased by as much as 300%.

Since then, Fannie Mae and Freddie Mac have created new conventional loan programs (like Fannie Mae HomeReady® and Freddie Mac Home Possible®) that offer borrowers many of the benefits of non-conventional mortgages without needing to meet the same eligibility requirements of a VA loan or an FHA loan.

Am I eligible for a conventional mortgage loan?

If you have a steady income, a credit score of 620 or higher and you aren’t overloaded with debt, you may be eligible.

The best way to find out for sure is to talk to a mortgage lender.

You’re on the Road to Homeownership

If you qualify for a conventional mortgage, you should be able to get preapproved and begin your homeownership journey.

If you don’t qualify, your mortgage lender can help you figure out if you qualify for a different mortgage that better fits your needs.

Where there’s a will, there’s a way!

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In Case You Missed It

Take-aways

  1. Conventional conforming loan options have expanded to include home renovation loans and loans with higher limits
  2. A growing number of conventional mortgages have benefits that are similar to government-backed mortgages
  3. Nonconforming conventional mortgages are an option, but choosing one carries a greater risk for borrowers

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