What is a conventional loan?
A conventional home loan is a type of mortgage that’s not directly insured by a government agency. Instead, these loans are supported by government-sponsored entities (GSEs) like Fannie Mae and Freddie Mac. These GSEs ensure the stability of the mortgage market by purchasing loans, allowing banks the flexibility to extend credit to new home buyers.
Conventional loans are one of the most popular loan options for home buyers with strong financial standing, generally requiring a good credit score and a down payment of 3% to 20%. Typically, conventional mortgages follow the down payment and income requirements set by Fannie Mae and Freddie Mac as well as the loan limits determined by the Federal Housing Finance Agency (FHFA).
How do conventional loans work?
When you think of a standard mortgage, conventional loans likely come to mind. But did you know they come in all shapes and sizes? Let’s check out the most common types, which can range in structure, loan terms and borrower requirements.
PRO TIP
Knowing how much home you can afford can help you quickly narrow down your loan options. Check out our Affordability Calculator and see where your house-hunting budget lands.
Conforming loans
These mortgages follow criteria set at the government level by Fannie Mae, Freddie Mac and the Federal Housing Finance Agency. If a loan meets the down payment, income and price limits, it’s considered a conforming loan and often comes with the perks of lower interest rates.
Nonconforming loans
Also known as portfolio loans, nonconforming loans don't meet Fannie Mae and Freddie Mac guidelines and are held by the lender. They offer flexibility for unique financial situations, but they may have higher interest rates and down payments.
Jumbo loans
As the name suggests, these nonconforming loans are reserved for big-ticket homes. Jumbo loans exceed conforming loan limits, meaning they can finance pricier properties if the borrower has good credit and solid savings.
Fixed-rate vs. Adjustable-rate mortgages (ARMs)
These loan types offer different payment structures. A fixed rate provides stability over the life of the loan because you pay one interest rate over the entire term, no matter how long it is (typically 15 or 30 years).
An adjustable-rate mortgage is less predictable—it starts with a low, fixed rate during the introductory period, but transitions to a variable rate that fluctuates with market conditions. Fixed-rate mortgages are ideal if you’re looking for a consistent mortgage payment, and ARMs work well if you plan on refinancing or selling the property in a few years—before the adjustable rate kicks in.
Low and no down payment options
If you’re a first-time home buyer or have modest savings, you may be able to bag a generous loan with little to no down payment, such as HomeReady and Home Possible loans.
Nonqualified mortgages
These loans have different eligibility criteria and can help borrowers with nontraditional income or a tricky financial background.
Conventional loan requirements
You already know that conventional loans come in many forms, and since they’re not backed by the government, lenders have the freedom to set their own standards when assessing potential borrowers. That said, most lenders follow similar guidelines when evaluating loan candidates. Here’s a cheat sheet:
- Credit score of 620+
- Down payment of 20% preferred (sometimes as low as 3%)
- Debt-to-income (DTI) ratio of ≤36%
- Private mortgage insurance (PMI) required with <20% down
Credit Score
Typically, lenders like to see a credit score of 620 or more for conventional loans. If you’re not at 620 now, you can work to improve your score by making payments on time and paying off some of your larger debts. Excellent scores of 740 and above may help you secure better interest rates.
Income and employment
Lenders require proof of a stable and consistent income. They typically require at least two years of employment history and will want to see some financial paperwork, including W2s, pay stubs and bank statements.
Down payment
While many conventional loans require a down payment of 20% or more, some conventional loan programs, like HomeReady and Home Possible, offer down payments as low as 3% for first-time home buyers and low-income borrowers.
Debt-to-income (DTI) ratio
Lenders often prefer a debt-to-income (DTI) ratio of 36% or lower for conventional loans. So, what is DTI and what does it have to do with loans? Your DTI ratio compares your total monthly debt payments to the amount you earn each month, demonstrating how well you handle debt. A low ratio shows lenders that you’re good at managing debt, which may help you get a great rate and lower monthly payments. If your DTI needs a little work, you can move the needle by paying down your high-interest debts.
Private mortgage insurance (PMI)
If you purchase a home with less than 20% down, private mortgage insurance is often required. This type of mortgage insurance protects the lender against default, which is when the loan cannot be repaid. The PMI premium you owe is established in part by your credit score and other factors. PMI is tacked onto your monthly payment until you reach 20% equity in the home, at which point you can request that private mortgage insurance be cancelled.
Conventional loan limits and interest rates
Conventional loan limits fall into two categories: conforming and nonconforming. Conforming loan limits are set by the Federal Housing Finance Agency (FHFA) and vary by location. To qualify for a conforming loan, your home’s purchase price must fall within the local loan limit. If you’ve set your sights higher, you’re looking at a nonconforming loan—commonly known as a jumbo loan. These loans come with stricter requirements, including a bigger down payment, stellar credit and a good chunk of savings.
The interest rate lenders offer you will depend on several factors: current market conditions, the type of loan and term you have and your financial profile (including your credit score and DTI ratio). Lenders evaluate all these details to assess risk, and that assessment plays a big role in determining your rate.
PRO TIP
The state of the housing market influences the size of the down payment you'll need. In a seller's market, where demand exceeds supply, a small down payment can make it harder to secure a loan or make a successful offer. In a buyer's market, where there are many homes available and not as much competition, a smaller down payment may do the trick.
How conventional loans compare to other loan types
Here’s how conventional loans stack up against popular government-backed mortgage options.
Conventional loan vs. FHA
If you have a lower credit score or a smaller down payment, an FHA loan may offer the wiggle room you need.
| Feature | Conventional Loans | FHA Loans |
|---|---|---|
| Down payment | Minimum 3%, but often higher | Minimum of 3.5% required |
| Mortgage insurance | PMI required if down payment is less than 20% | Upfront and annual premiums required |
| Interest rates | Usually higher, influenced by credit score | Generally lower than conventional loans if credit is good |
| Credit score requirements | Typically, 620+ required | Minimum 580 in most circumstances |
| Purpose | Generally for consumers with better credit/finances | To help lower- or moderate-income folks become homeowners |
Conventional vs. VA loans
While conventional loans are open to anyone, VA loans help veterans, service members and surviving spouses. VA loans are packed with perks, including lower rates, zero down payments and no mortgage insurance.
| Feature | Conventional Loans | VA Loans |
|---|---|---|
| Down payment | Minimum 3%, but often higher | Zero down payment with 100% VA Loan Guaranty Benefit |
| Mortgage insurance | PMI required if down payment is less than 20% | No PMI required, but includes funding fee |
| Interest rates | Usually higher, influenced by credit score | Lowest average rates on the market, not as credit-dependent |
| Credit score requirements | Typically, 620+ required | Typically, 620, but lower scores can be accepted |
| Purpose | Generally for consumers with better credit/finances | Flexible and forgiving for veterans/service members |
Conventional vs. USDA loans
If you have a lower income and your heart is set on the countryside, a USDA loan can help you settle in a designated rural region with no down payments and a lower rate than conventional loans.
| Feature | Conventional Loans | USDA |
|---|---|---|
| Down payment | Minimum 3%, but often higher | Zero down payment |
| Mortgage insurance | PMI required if down payment is less than 20% | No PMI, but an upfront and annual fee |
| Interest rates | Usually higher, influenced by credit score | Generally lower than conventional loans |
| Credit score requirements | Typically, 620+ required | Typically, 640+, but could be lower based on lender |
| Purpose | Generally for consumers with better credit/finances | To help lower-income folks settle down in designated rural areas |
How do I apply for a conventional loan?
Whether you’re starting to hit open houses or ready to hit the “Apply Now” button, you should understand the homebuying process and how to apply for a mortgage step by step.
- Check your credit score
Before applying, look up your credit report to see where you may stand with lenders and which loans you could qualify for. - Gather necessary documents
You need to provide official documents including your SSN, proof of income, tax returns, employment verification and a list of assets and liabilities. - Get preapproved
Before you get your heart set on a home, get preapproved for a loan amount. A lender reviews your financial documents and determines how much you may be able to borrow. A preapproval letter can give you a leg up with sellers, showing that you’re a serious buyer with financing lined up. - Submit your application
Once you’ve found a home you love and have your pre-approval letter, submit your application along with all required documentation. A lender has three business days to review your application and give you a Loan Estimate: a disclosure of your projected loan amount, type, interest rate and additional mortgage costs. - Undergo loan processing
The lender formally reviews your application, performs a credit check and appraises the property to ensure everything is in order. Be ready to field questions from your lender and be sure not to disturb your credit score—avoid major purchases or new lines of credit. - Wait for underwriter’s decision
Once your information is verified, the underwriter completes their risk assessment by examining your loan-to-value ratio, credit history, DTI, employment history and home valuation to determine if you’re a good fit. - Close the loan
If all goes well, you get the seal of approval! Your lender sends the Closing Disclosure three business days before your closing date, outlining the final costs in detail. Compare it to the Loan Estimate and ask about any discrepancies. If all looks good, you sign the paperwork and handle the closing costs. Closing costs typically range from 2% to 6% of the loan amount and can be paid as a lump sum or rolled into the total cost of the loan.
Need expert advice before you apply?