What Is a Conventional Mortgage?
Buying a home is exciting, but figuring out how to finance it? That part can feel overwhelming. If you’ve started looking into your options, you’ve probably come across the term conventional mortgage, one of the most popular ways home buyers secure a loan. But what does it actually mean?
A conventional loan is a mortgage that isn’t backed by the government. It’s offered by private lenders like banks, credit unions, and mortgage companies, and it follows lending rules set by Fannie Mae and Freddie Mac. If you have a good credit score and stable income, it can be a great way to get a lower interest rate and more flexibility.
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How Does a Conventional Loan Work?
A conventional loan is one of the most common ways home buyers finance a property. Unlike loans backed by government agencies like the Federal Housing Administration (FHA) or USDA loan programs, these are offered by private lenders, think banks, credit unions, and mortgage lenders.
You borrow money to cover the purchase price, and in return, you agree to repay the loan amount over a set term, usually 15, 20, or 30 years. Your monthly mortgage payment includes the principal, interest, and sometimes private mortgage insurance (PMI) if your down payment is less than 20%.
Your interest rate depends on several factors, including your credit score, loan type, and lender. A fixed-rate loan keeps your monthly payment predictable, while an adjustable-rate mortgage (ARM) can start low but change over time.
If you qualify, a conventional mortgage can be a good option with more flexibility and lower interest rates than some government-backed loans.
Conventional Loan Requirements
Lenders don’t hand out mortgage loans to just anyone. They follow guidelines from Fannie Mae and Freddie Mac, evaluating your financial health before approving a loan.
Credit Score
Your credit score plays a big role in your loan terms. A higher credit score (typically 700 or above) helps you secure lower interest rates, which can save you thousands over time.
A score of 620 is usually the minimum credit score required, but anything lower could mean higher interest rates and stricter terms.
Debt-to-Income (DTI) Ratio
Your monthly income compared to your existing debts tells lenders how much risk they’re taking.
A DTI ratio of 43% or lower is ideal, but some mortgage lenders allow higher ratios if other financial factors, like a strong credit report or a larger down payment, offset the risk.
Down Payment
A bigger down payment lowers your loan amount, which can mean a lower monthly payment and no PMI. While some conventional loans require down payment options as low as 3%, down payments of 20% or more can save you money in the long run.
If your down payment is small, private mortgage insurance will be added to your monthly mortgage payments until you reach enough equity in your home.
Property Value
The purchase price must align with the home’s actual worth. That’s why lenders require an appraisal before approving your mortgage loan. If the home’s value doesn’t match the loan amount, you may need to renegotiate the price or adjust your loan type.
Loan Approval and Repayment
Once your mortgage lender approves your conventional mortgage, you’ll make monthly payments based on your loan terms.
If you choose a fixed-rate loan, your monthly mortgage payment stays the same. If you go with an adjustable-rate mortgage, expect higher interest rates over time, depending on the market.
Types of Conventional Loans
A conventional loan isn’t one-size-fits-all. Borrowers have different financial situations, homeownership goals, and risk tolerance, so lenders offer multiple options. Understanding the differences between these types of conventional loans can help you choose the best loan type for your needs.
Fixed-Rate Loan
A fixed-rate loan comes with a locked-in interest rate, meaning your mortgage payments remain the same for the entire term of the loan. This makes budgeting easier, as there are no surprises when it comes to your monthly payments.
A fixed-rate mortgage is one of the most common mortgage options, especially for buyers planning to stay in their property long-term. These loans are available in various loan terms, with 30-year and 15-year terms being the most popular.
While shorter terms often come with a lower interest rate, they also mean higher monthly payments since the loan amount is repaid over a shorter period.
Adjustable-Rate Mortgage (ARM)
Unlike a fixed-rate loan, an adjustable-rate mortgage (ARM) starts with a fixed interest rate for a set number of years, typically 5, 7, or 10, before adjusting periodically based on market conditions.
This initial lower interest rate can make ARMs appealing to home buyers looking for reduced mortgage payments in the early years of their loan. However, once the fixed period ends, the interest rate adjusts, which could lead to higher monthly payments.
Since rates fluctuate, ARMs carry more uncertainty and risk, making them a better fit for borrowers who don’t plan to stay in their home long-term or who expect their income to increase over time.
Conforming Loan
A conforming loan is a conventional mortgage that meets the Federal Housing Finance Agency (FHFA) limits and lending guidelines. These loans qualify for purchase by Fannie Mae and Freddie Mac, allowing lenders to offer lower interest rates and more favorable loan terms to eligible borrowers.
The maximum loan amount for a conforming loan varies by location. In most areas, the limit is set by the FHFA, but in a high-cost county, the limit is higher to reflect increased property values.
Since they conform to standardized lending requirements, these loans tend to have lower fees and more predictable terms compared to non-conforming loans.
Non-Conforming or Jumbo Loan
A non-conforming loan, often called a jumbo loan, exceeds the conforming loan limits set by the FHFA. These loans are used for high-priced properties where the loan amount is too large for Fannie Mae or Freddie Mac to purchase.
Because jumbo loans pose more risk to lenders, they come with stricter requirements. Borrowers typically need a higher credit score, a larger down payment, and strong financial documentation to qualify.
Additionally, these loans often carry a higher interest rate compared to a conforming conventional loan due to the increased risk involved.
What Is the Difference Between a Conventional Mortgage and a Non-Conventional Mortgage?
The key difference between a conventional mortgage and a non-conventional mortgage is whether or not it’s backed by a government entity.
A conventional mortgage is issued by a private lender, like a bank, credit union, or mortgage lender, without direct government backing. This means borrowers typically need good credit, a steady monthly income, and a down payment to qualify.
On the other hand, non-conventional loans, like FHA loans, VA loans, and USDA loans, are backed by a government program.
These loans often have lower credit score and down payment requirements, making them more accessible to first-time home buyers or those with less-than-perfect credit. However, they may also include additional fees and private mortgage insurance (PMI), which can add to the overall cost of the loan.
Conventional Loans vs. Other Loan Types
Here’s how a conventional loan compares to other common mortgage options:
Conventional vs. FHA
An FHA loan, backed by the Federal Housing Administration, is designed for borrowers with lower credit scores or smaller down payments.
While FHA loans offer more lenient credit score requirements, they also come with mortgage insurance premiums (MIP), an extra cost that remains for the loan’s lifetime unless refinanced.
In contrast, a conventional mortgage often requires a higher credit score and a larger down payment, but it allows borrowers to avoid ongoing PMI once they reach 20% equity in their home.
Conventional vs. VA
A VA loan, backed by the government, is exclusively available to eligible military members, veterans, and their families. It requires no down payment, no PMI, and offers competitive interest rates, making it a valuable benefit for those who qualify.
However, for home buyers who aren’t eligible for a VA loan, a conventional mortgage can be a great alternative, offering flexibility in loan terms and the potential for lower interest rates with a strong credit score.
Conventional vs. Jumbo
A jumbo loan is a non-conforming loan that exceeds the conforming loan limits set by the FHFA. Because these loans are larger, they come with stricter lending requirements, including a higher credit score, larger down payment, and often a higher interest rate.
A conventional mortgage, in contrast, falls within standard conforming loan limits and is typically easier to qualify for. If you're financing a high-value property, you’ll need to determine whether a jumbo loan or a portfolio loan from a private lender is the best fit for your situation.
Pros and Cons of a Conventional Mortgage
Pros
- You can avoid mortgage insurance if you put down 20% or more
- PMI can be removed once you build enough equity
- Interest rates are often lower if you have strong credit
- You can use it for a primary home, second home, or investment property
- Loan terms are flexible, including fixed and adjustable-rate options
Cons
- You’ll usually need a higher credit score to qualify
- You’ll usually need a higher credit score to qualify
- PMI adds to your monthly cost if your down payment is under 20%
- It can be harder to qualify if your income or credit history isn’t solid
How to Apply for a Conventional Mortgage?
Finding the right mortgage loan is all about understanding your options. A conventional mortgage can be a smart choice if you have a good credit score and a solid down payment, offering lower interest rates and flexible terms.
Whether you’re buying your first home or refinancing, choosing the right loan type can make a big difference in your financial decisions.
If you’re ready to take the next step, Rate’s mortgage experts can help you explore the best loan options for your needs, so you can move forward with confidence.
Guaranteed Rate, Inc. is a private corporation organized under the laws of the State of Delaware. It has no affiliation with the US Department of Housing and Urban Development, the US Department of Veterans Affairs, the US Department of Agriculture, or any other government agency.
