What is a conventional loan?

Group of friends sitting together in the back yard, discussing conventional loans as they consider home-buying optionsImage: Group of friends sitting together in the back yard, discussing conventional loans as they consider home-buying options

In a Nutshell

Mortgages that aren’t part of government programs (like FHA loans and VA loans) are known as conventional loans. A conventional loan may be worth a look if you have solid credit and have some money to put toward a decent-size down payment.
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If you’re shopping for a mortgage, you may hear the term “conventional loan.”

A conventional loan is a mortgage issued by a private lender without going through a government program. When someone says that a mortgage is a conventional loan, they’re distinguishing it from FHA loans, VA loans or USDA loans.

While this is an industry term, lenders that offer conventional loans don’t always label their mortgages this way on their websites. They may simply refer to conventional loans as mortgages or, more descriptively, call them fixed-rate or adjustable-rate mortgages.

What are the different types of conventional loans?

Conventional mortgage loans can be either conforming or nonconforming. Here’s a little about what those terms mean.

Conforming loans

Conforming loans are mortgages that adhere to maximum loan amounts determined by the government or other rules set by Fannie Mae or Freddie Mac. They are government-sponsored companies that agree to pay lenders if borrowers default on certain types of mortgages.

The Federal Housing Finance Agency determines the maximum amount that conforming loans can’t exceed. For 2021, a single-unit property qualifies for a conforming loan of up to $548,250 in most areas of the U.S.

Note that there are exceptions for Alaska, Hawaii, Guam, the U.S. Virgin Islands and other parts of the country with high costs of living. The highest loan limit in these regions is $822,375. Mortgages with these large loan amounts are known as conforming jumbo loans.

Nonconforming loans

Loans are nonconforming if they’re larger than the highest amount allowed by the FHFA in an area or they deviate from other requirements of conforming loans. Some nonconforming loans are targeted at people in special situations, such as people who are buying a big stretch of land or people who are self-employed.

Other nonconforming loans are aimed at homebuyers who are seen as more likely to default. These mortgages are usually expensive and might include arrangements that wouldn’t be acceptable for a conforming loan, such as permitting the borrower to make interest-only payments for a certain period of time.

Fixed or adjustable rate

Conventional home loans can have fixed mortgage rates or adjustable rates. With a fixed-rate loan, the interest stays the same over the entire life of the loan, and the borrower makes the same principal and interest payments every month. With an adjustable-rate mortgage, the interest rate remains the same during a set period of time at the beginning of the loan. After that time, the rate can go up or down, and the amounts owed each month for the principal and interest can also change.

What is the minimum down payment for a conventional loan?

Conventional wisdom says that homebuyers should make a down payment of at least 20% of a home’s price to keep monthly costs lower and establish equity in the property. And if your down payment is at least 20%, you usually aren’t required to buy private mortgage insurance. Fannie Mae and Freddie Mac view loans with a down payment that size as less risky and are willing to guarantee them even if the borrower doesn’t have private insurance.

At the same time, coming up with a 20% down payment is easier said than done. Particularly for people buying their first home, it’s not always possible to put 20% down.

You may be able to get a conventional loan with a lower down payment, though you should expect to be charged higher interest and fees. Some lenders allow down payments as low as 3%.

The median price for an existing single-family home was $313,500 in the third quarter of 2020, according to the National Association of Realtors. A down payment of 3% on a home with that price would be $9,405.

It’s common for lenders to ask for at least a 5% down payment, though. That amounts to a down payment of $15,675 on the median-priced home.

Is it hard to get a conventional loan?

Whether you’re likely to be approved for a conventional loan depends largely on your credit. Lenders typically want borrowers with credit scores above the mid-600s. And you have a better chance of being offered a competitive interest rate if your credit scores are in the mid-700s or higher.

If your credit isn’t great, you might find it easier to qualify for an FHA loan. An FHA loan is often less expensive than a conventional mortgage if your credit scores are on the lower side or if you want to make a down payment of less than 10%.

People with a bankruptcy or foreclosure may be more likely to get approved for an FHA loan than for other types of loans. But FHA loans are generally more expensive than conventional loans if you have good credit and are able to make a sizable down payment.

Also, the appraisal process is more stringent for FHA loans than conventional loans. While lenders typically require an appraisal before issuing a mortgage to determine the home’s value, an appraisal for an FHA loan assesses both the property’s value and whether it meets eligibility requirements for the program.

Homes must meet detailed requirements for things like structural soundness and well-functioning plumbing and electrical systems, and must not present any health or safety issues. If the appraisal reveals problems, the seller would have to make repairs before the buyer could get an FHA loan. If the property can’t be brought up to standard without extensive improvements, obtaining an FHA loan might not be possible.

A seller who doesn’t want to deal with this appraisal process might be less eager to accept an offer financed with an FHA loan than an offer financed with a conventional loan.

What type of mortgage is right for me?

Whether you’ll be better off with a conventional loan or a mortgage through the FHA or another program depends on your individual finances.

Here are some questions to ask yourself to help you decide.

If you answered “yes” to these questions, a conventional loan might be right for you. You’ll also want to consider your debt-to-income ratio and what monthly payment your budget can afford.

Either way, it’s a good idea to contact several lenders to learn more about which loans you might qualify for and to compare your options.

About the author: Sarah Brodsky is a freelance writer covering personal finance and economics. She has a bachelor’s degree in economics from The University of Chicago. Sarah has written for companies such as Hcareers, Impactivate and K… Read more.