What is a Conventional Loan?
A conventional loan is a mortgage that is not insured or guaranteed by the federal government. Unlike FHA, VA, or USDA loans, conventional mortgages are backed solely by private lenders and must meet guidelines set by Fannie Mae and Freddie Mac, two government-sponsored enterprises that purchase mortgages from lenders.
Conventional loans are the most common type of mortgage in the United States, accounting for the majority of home purchases. They offer competitive interest rates and flexible terms for borrowers who meet the credit and down payment requirements.
Key Takeaway
Conventional loans offer competitive rates, the ability to remove PMI at 20% equity, and down payments as low as 3% for qualified first-time buyers. They're ideal for borrowers with good credit and stable income.
Types of Conventional Loans
Conforming vs. Non-Conforming Loans
Conforming loans meet the loan limits set by Fannie Mae and Freddie Mac. For 2024, the conforming loan limit is $766,550 in most areas and up to $1,149,825 in high-cost areas. These loans typically offer the best rates and terms.
Non-conforming loans (also called jumbo loans) exceed these limits. They typically require larger down payments, higher credit scores, and come with slightly higher interest rates due to increased lender risk.
Fixed-Rate vs. Adjustable-Rate Mortgages
Fixed-rate mortgages maintain the same interest rate for the entire loan term, providing predictable monthly payments. Common terms are 15, 20, and 30 years.
Adjustable-rate mortgages (ARMs) have interest rates that adjust periodically based on market conditions. They often start with lower rates than fixed-rate mortgages but can increase over time.
Main Benefits of Conventional Loans
Competitive Interest Rates
Borrowers with good credit typically receive lower interest rates than government-backed loans.
Removable PMI
Private mortgage insurance can be removed once you reach 20% equity, unlike FHA loans where MIP lasts longer.
Flexible Property Types
Can be used for primary residences, second homes, and investment properties with varying down payment requirements.
Lower Down Payment Options
First-time buyers can qualify with as little as 3% down through programs like HomeReady® and Home Possible®.
Higher Loan Limits
Conventional loans offer higher limits than FHA loans in many markets, allowing you to purchase more expensive homes.
No Upfront Funding Fee
Unlike FHA loans, there's no upfront mortgage insurance premium that must be financed into the loan.
Conventional Loan Requirements
Credit Score
Conventional loans generally require higher credit scores than government-backed loans:
- 620 minimum: Required for most conventional loans
- 680+: Qualifies for better interest rates and terms
- 740+: Receives the best available rates
Down Payment
Down payment requirements vary based on the loan program and property type:
- 3% down: Available for first-time buyers (HomeReady® and Home Possible® programs)
- 5% down: Standard for most conventional loans
- 10% down: Often required for investment properties and vacation homes
- 20% down: Avoids private mortgage insurance (PMI)
Debt-to-Income Ratio
Your DTI ratio compares your monthly debt payments to your gross monthly income. Conventional loans typically require:
- Front-end ratio: Housing expenses should not exceed 28% of gross income
- Back-end ratio: Total debt should not exceed 36-43% of gross income
Employment and Income
Lenders typically want to see at least two years of steady employment and income. Self-employed borrowers will need to provide additional documentation, including tax returns and profit/loss statements.
Cash Reserves
Depending on the loan amount and down payment, you may need to show cash reserves equal to 2-6 months of mortgage payments. This demonstrates your ability to handle unexpected expenses.
Understanding Private Mortgage Insurance (PMI)
If you put down less than 20% on a conventional loan, you'll be required to pay private mortgage insurance (PMI). PMI protects the lender if you default on the loan.
How Much Does PMI Cost?
PMI typically costs between 0.3% and 1.5% of the original loan amount annually, divided into monthly payments. On a $300,000 loan, that's approximately $75-$375 per month depending on your down payment and credit score.
When Can You Remove PMI?
One major advantage of conventional loans is the ability to remove PMI:
- Automatic removal: At 78% loan-to-value ratio based on original payment schedule
- Request removal: At 80% LTV with good payment history
- Reappraisal: If home value increases significantly, you may request early removal
Conventional Loan Programs
HomeReady® Mortgage (Fannie Mae)
Designed for low-to-moderate income borrowers, HomeReady® offers:
- 3% down payment for first-time and repeat buyers
- Flexible income sources (boarder income, non-borrower income)
- Reduced PMI compared to standard conventional loans
- Income limits apply (80% of area median income)
Home Possible® Mortgage (Freddie Mac)
Similar to HomeReady®, this program provides:
- 3% down payment requirement
- Flexible credit requirements
- Lower PMI rates
- Income restrictions apply
Standard Conventional Loans
For borrowers who don't qualify for special programs, standard conventional loans offer flexible terms with competitive rates for those with good credit and stable income.
Who Should Consider a Conventional Loan?
Conventional loans are ideal for:
- Buyers with good credit (680+) who can qualify for competitive interest rates
- Borrowers planning to reach 20% equity relatively quickly to eliminate PMI
- Buyers exceeding FHA loan limits who need a larger mortgage amount
- Investment property buyers looking to purchase rental properties or vacation homes
- Repeat buyers with established credit and home equity to use as down payment
The Conventional Loan Process
Getting a conventional loan through Bedrock Mortgage follows these steps:
- Step 1: Pre-qualification — Discuss your financial situation with a Loan Officer to understand your options
- Step 2: Complete application — Submit your formal mortgage application with supporting documentation
- Step 3: Get pre-approved — Receive your pre-approval letter to begin house hunting
- Step 4: Find your home — Work with a real estate agent to make an offer
- Step 5: Underwriting — Lender reviews your application and orders appraisal
- Step 6: Clear to close — Receive final approval and schedule closing date
- Step 7: Closing — Sign documents and receive the keys to your new home!
Frequently Asked Questions
What's the difference between conventional and FHA loans?
The main differences are that conventional loans typically require higher credit scores and down payments but offer more flexibility in property types and the ability to remove PMI at 20% equity. FHA loans are government-insured, accept lower credit scores, and require lower down payments but have mortgage insurance for the life of the loan (unless you put down 10% or more).
Can I buy a second home or investment property with a conventional loan?
Yes! Conventional loans can be used for primary residences, second homes, and investment properties. Down payment requirements and interest rates will vary based on property type and occupancy.
How is my interest rate determined?
Your interest rate is based on multiple factors including your credit score, down payment amount, loan term, property type, occupancy status, and current market conditions. Generally, higher credit scores and larger down payments result in lower rates.
Can I pay off my conventional loan early?
Yes, conventional loans typically do not have prepayment penalties. You can make extra payments or pay off your loan early without additional fees. Always confirm with your lender, as some loans may have prepayment penalty clauses.
What documents will I need to apply?
Common documents include recent pay stubs, W-2s or tax returns (typically 2 years), bank statements, employment verification, identification, and information about your debts and assets. Self-employed borrowers will need additional business documentation.