Buying a home is one of the biggest purchases you’re likely to make in your life. And the type of mortgage loan used to purchase your home is likely to be one of the biggest decisions you’ll need to make as part of this process. For most people, the go-to choice is a conventional loan.
Here’s what you need to know about conventional loans and how to determine whether getting one is right for you.
What is a conventional loan?
A conventional loan is a type of loan that isn’t insured or guaranteed by the government but one you can get from a private mortgage lender. Other types of mortgages, like Federal Housing Administration (FHA), Department of Veterans Affairs (VA) and U.S. Department of Agriculture (USDA) loans are backed by different government agencies.
The vast majority of new home loans — more than 76% of new home sales — are conventional loans. More than half of first-time homebuyers are using conventional loans to buy their homes over other types of financing. It’s far and away the most popular type of home loan for buyers.
How a conventional loan works
The major difference in how a conventional loan works compared to other types of loans is where it comes from.
“Since a conventional loan is a mortgage not insured by the federal government,” says Markia Brown, a certified financial education instructor and founder of The Money Plug. “That means the lender assumes more risk if the borrower defaults on the loan.”
When you complete a loan application, you’re working with a private lender who determines if you’re eligible to borrow. In most cases, you can qualify with decent credit and a down payment as low as 3% to 5%, depending on the home cost and your credit history.
Types of conventional loans
Conventional loans are not one-size-fits-all. There are a few different types of conventional loans and the one you choose depends on many different factors.
“The distinctions between the different types of conventional loans primarily revolve around the loan’s structure, the borrower’s creditworthiness and whether the lender holds the loan or sells it on the secondary market,” Brown says.
In general, there are two major types of conventional loans:
- Conforming loans: These types of conventional loans have a maximum loan amount that the government sets. The most common type of conventional loan is a conforming loan. Limits depend on the county you live in.
- Non-conforming loans: Lenders set the standards you need to meet to get this type of loan. Loans that don’t fit into conforming jumbo or conventional conforming guidelines and borrowing limits are often non-conforming loans.
But there are also other types of conventional loans to look out for:
- Jumbo loans: These types of loans depend on where you live and the limits set by your county. You can get a jumbo conforming loan or a jumbo non-conforming loan.
- Fixed-rate loans: These conventional loans have fixed monthly payments that don’t change over the life of your loan.
- Adjustable-rate loans: An adjustable-rate mortgage (ARM) has monthly payments that can change, so keep this in mind as you’re making room for a mortgage in your budget.
How to qualify for a conventional loan
If you’re thinking about getting a conventional loan, here are a few things you need to qualify:
- Decent credit: While excellent credit means you’ll likely qualify for the lowest interest rate available, you could still get a loan with good or even fair credit. Though some lenders require a score of 660 to qualify, you still might qualify with fair credit (around 620) with some lenders.
- Down payment: You don’t necessarily need to put 20% down to qualify for a conventional loan. It’s possible to secure a conventional loan with as little as 3% down. Some loan programs require no down payment at all. But having 20% or more of your total loan amount means you don’t need to get private mortgage insurance (PMI).
- Low DTI: Your debt-to-income ratio, or DTI, is how much debt you have in relation to how much you earn. It is usually expressed as a percentage. The lower your DTI, the more likely you are to stay current on your mortgage if you ever face a financial emergency (like losing your job or getting injured and being unable to work for a while). Aim for a DTI of less than 50% — and if you can, around 43% or less.
How to apply for a conventional loan
If you’re ready to get a conventional loan, here are some things you need for your application:
- Check your credit. Before your lender pulls your credit report, check your credit score and history. You can do this through your credit card issuer, bank and through AnnualCreditReport.com. This helps you figure out what interest rate you might be eligible for and helps you estimate monthly payments.
- Get pre-qualified. Getting pre-qualified with a few different lenders doesn’t require completing a full application, but can give an idea of how much of a loan you’d be approved for, along with estimated payments and loan terms. It only involves some basic information and a soft credit check — which won’t affect your credit.
- Compare lenders. Once you find a few mortgage options you like, compare them based on interest rates and any potential fees or charges. Also, look to see if you qualify for any discounts or deals. Once you’ve decided on the right lender for you, complete your full application.
- Get preapproved. Preapproval is completing a full application for a home loan. A lender checks your credit score, history, banking details, tax returns and other financial information. A preapproval letter indicates to sellers that you’re serious about buying and may even speed up your homebuying process.
- Start house-hunting. With a preapproval letter, you’ll know how much home you can afford. The next step is to find a home you like and submit an offer.
Keep in mind: Between the preapproval of your mortgage and full approval, it’s important that you not make any large purchases or changes to your finances. For example, if you apply for a credit card or buy a new car, your credit score could drop and that could cause you to get denied a mortgage.
Pros and cons of a conventional loan
Pros
- Can be easier to get: Government-backed loans usually have more requirements to meet, like being a military member or buying a property in a specific area, making a conventional mortgage easier to get in that aspect. Plus, conventional loans often require less paperwork than FHA loans, for example.
- Lower down payment: Some conventional loans require a 20% down payment, but you can still get one with as little as 3% down — FHA loans, for example, require a down payment of 3.5% to 10%.
- PMI can be removed: If you have less than 20% down, you’re required to get private mortgage insurance as part of your conventional loan. However, you can get PMI removed once you’ve hit 20% equity in your home.
Cons
- Higher credit score needed: You generally need a credit score of 620 or more for a conventional loan, while FHA loans usually only require a score of 500 to 580.
- No streamline refinance: Although you can still refinance a conventional loan, these loans don’t offer a streamlined option, whereas some government-backed loans do. A streamlined refinance uses the same paperwork as your original loan, which can speed up the refinancing process significantly.
- Can be hard to get after financial trouble: Conventional loans are more difficult to get if you have any sort of bankruptcy. For example, you have to wait two to four years after Chapter 7 or Chapter 13 bankruptcy to get a conventional loan. But you could get an FHA or VA loan after just waiting for one year.
Compare some of the best online mortgage lenders to find the right home loan for you.
Conventional vs. government-backed loans
While conventional loans come from private lenders and banks, there are other types of mortgages that are government-insured, such as:
- FHA loans are a type of government-backed loan targeting first-time homebuyers with low credit. They’re easier to qualify for compared to conventional loans — usually a 580 credit score — with down payments as low as 3.5%.
- VA loans are home loans targeting veterans and active-duty military folks. Most VA loans will back your loan up to 100% and don’t have a down payment or minimum credit score requirement.
- USDA loans are for homebuyers looking to purchase in rural areas. Most USDA loans are available without a down payment and offer 100% financing, even for folks who don’t have great credit.
Current conventional loan rates
The lowest conventional mortgage rates are offered to borrowers with excellent credit scores and a history of on-time payments. Mortgage rates change often and are based on economic indexes and how the market is performing. For instance, when the Federal Reserve raises interest rates, savings accounts can get higher interest rates, but so can mortgages.
Check out: Current mortgage interest rates
Frequently asked questions (FAQs)
This depends on your situation. FHA loans are available to folks who might not have the best credit or much money available for a down payment. While an FHA loan can help some people who might not otherwise qualify buy a home, it may not necessarily be the best loan for everyone. FHA loans come with additional costs and higher interest rates than conventional loans, so it’s a good idea to check to see which type of loan gives you the most cost-effective option.
Conventional loans are best if you have good to excellent credit and minimal debt (low DTI) — which should qualify you for the lowest interest rate available.
