What is a Conventional Loan?

Conforming mortgage loans meet the requirements of Fannie Mae and Freddie Mac and are therefore conventional. The government-sponsored enterprises Fannie Mae and Freddie Mac purchase mortgages from lenders and sell them to investors. Lenders can then get more qualified buyers into homes because their funds are freed up.

Among the types of non-conforming mortgages are jumbo loans, which are loans exceeding conforming loan limits.

Because conventional loans fall under several different sets of guidelines, there is not a single set of requirements for borrowers. Contrary to popular belief, conventional loans generally require a higher credit score than government-backed loans such as FHA loans.

How Conventional Loans Work?

The traditional loan process works as follows: the bank (or credit union, or lending agency) purchases your property and gives it to you; however you promise to repay the lender with interest.

You pay the bank interest for the trouble of lending you money, and that is how the bank makes money after you have lent them such a large sum. The interest rate is either fixed or adjustable; in the latter case, it typically changes once per year depending on the state of the economy. Conventional loans also vary in interest rates based on your own financial profile (more on that further down).

A wide range of mortgage products are available to consumers, with varying interest rates and requirements, but conventional loans tend to be more specific. You’ll find a difference between conforming and non-conforming loans between the two types of mortgage products.

The length of a conventional mortgage is generally 15 or 30 years; the type you choose depends on your personal financial situation, your income, and the interest rate you can obtain.

How to Qualify for a Conventional Loan

Qualification requirements include the following:

• The debt-to-income ratio should be under 43% (potentially lower if your credit is not great).
• A credit score of 640 or higher is required.
• You’ll need a down payment of at least 3% (20% if you don’t want to pay mortgage insurance)

As long as borrowers have good or excellent credit and household incomes over $60,00 to $75,000 per year, lenders often assume little risk on conventional loans sold to government entities. As a result, borrowers can usually get the lowest interest rates available.

You should consider a conventional loan if:

• Those with regular, consistent pay stubs from stable, full-time jobs
• Three or more years of consistent, reliable income for self-employed people
• Married couples who have moderate to high household incomes and little debt

Conventional Loan Requirements

Down Payment

With a conventional mortgage, first-time homebuyers can put as little as 3% down. You may be required to pay a down payment depending on your personal circumstances and the type of loan or property you’re getting:

• You must make no more than 80% of the median income in your area to meet the 5% down payment requirement if you are not a first-time homebuyer.
• If the house you’re buying is not a single-family home (that is, it has more than one unit), you may have to put down 15%.
• In order to buy a second home, you’ll need to put down at least 10%.
• The minimum down payment for an adjustable-rate mortgage is 5%. 

In order to refinance a conventional loan, you’ll need more equity than 3%. All conventional loans require at least 5% equity. When you do a cash-out refinance, you’ll need to leave at least 20% equity in the house.

Calculating your future mortgage payments with a mortgage calculator can help you estimate your down payment amount.

Private Mortgage Insurance

A conventional loan with less than 20% down will require you to pay private mortgage insurance (PMI). This insurance protects your lenders if you default on your loan. Your PMI cost will vary depending on your loan type, your credit score, and the amount of your down payment.

In most cases, PMI is paid as part of your monthly mortgage payment, but there are other ways to cover the cost as well. Some buyers include PMI in their closing costs. Other buyers pay it by increasing their interest rates. Calculate which option is the least expensive for you by running the numbers. 

PMI, on the other hand, won’t stay on your loan forever, so you won’t need to refinance to get rid of it. Your lender may remove the PMI from your mortgage payments when you reach 20% equity in the home on your regular mortgage payment schedule.

If your home’s value increases by 20%, you can contact your lender to request a new appraisal so they can use the new value to recalculate your PMI requirement. As soon as you reach 22% equity in the home, your lender will automatically remove PMI from your loan.

Other Conventional Loan Requirements

• In most cases, you’ll need a credit score of at least 620 in order to qualify for a conventional loan. If you apply for a loan, your lender will check your credit history to determine if you have good credit. Without good credit, you might not qualify for the loan.
• You can measure your debt-to-income ratio by dividing your monthly income by the percentage of the debt you owe. The DTI can be calculated by taking the minimum monthly payments on all of your debts (such as student loans, auto loans, and credit cards) and dividing it by your gross monthly income. Your debt-to-income ratio (DTI) must be at least 50% for most conventional loans.
• To qualify for a conforming conventional loan, your loan must fall within the Fannie Mae and Freddie Mac loan limits. The loan limits change annually. A single-family home can be financed up to $647,200 for 2022. Exceptions apply, however. The maximum loan limit in Alaska, Hawaii, and other high-cost areas of the country is $970,800.

Advantages of Conventional loans

• Faster Loan Underwriting- Government-insured loans may require more paperwork and can be obtained more quickly than conventional loans. Conventional loans can be approved quickly without the typical delays associated with FHA or government-backed loans. In addition, conventional loans don’t require an exhaustive FHA inspection, which can require time-consuming repairs.
• More Options- There are many types and sizes of conventional loans. Would you prefer a fixed-rate mortgage for 10 years? We’d like an adjustable-rate mortgage for seven years. These options can only be found through a conventional loan.
• Optional Escrow Accounts- Typically, conventional loans offer the option to pay your taxes and insurance directly, instead of adding them to your monthly mortgage payment through an escrow account. A conventional mortgage is the only option for those who want the flexibility and freedom to pay taxes and insurance separately.
• Security- A conventional mortgage is usually a fixed-rate product, meaning that once an interest rate is set, the borrower will have to pay that rate for the entire loan term. The monthly payment remains the same, regardless of whether interest rates rise or housing prices fall. While interest rates may be low enough to make refinancing attractive, conventional mortgages have the advantage of flexibility because borrowers have already met the tough requirements to qualify.

Adjustable Conventional Loans

Variable-rate mortgages have variable interest rates. Initial interest rates on an ARM are lower than those on a comparable fixed-rate loan, and they rise as time goes on. A long-term ARM will exceed the going rate for a fixed-rate loan if it is held long enough.

In an ARM, the initial interest rate remains constant for a predetermined period of time, then the interest rate adjusts at a predetermined interval. Generally, shorter adjustment periods are associated with lower initial interest rates; longer periods are associated with higher initial interest rates.

Conventional Loans Rates

Conforming Loan Limits

As of 2006-2008, the conforming loan limit for mortgages for single-family, one-unit properties increased from $33,000 in the 1970s to $417,000, with limits 50 percent higher in four statutorily-designated high-cost regions: Alaska,  Hawaii, Guam, and the U.S. Virgin Islands.  In certain high-cost areas in the United States, various legislative acts have increased conforming loan limits since 2008.  Under the Housing and Economic Recovery Act of 2008 (HERA), a permanent formula was established for loans that originated during selected periods of time.  HERA has set the conforming loan limits for 2022.