What Is a Conventional Loan?
A conventional loan is a mortgage that is not insured or guaranteed by a government agency. Conventional mortgages are commonly used to purchase primary residences, second homes, and investment properties, although eligibility and requirements vary by loan program.
Conventional loans are generally divided into two categories: conforming loans and non-conforming loans.
Conforming loans meet the guidelines established by Fannie Mae and Freddie Mac, including applicable loan limits. Non-conforming loans do not meet those guidelines and may include jumbo mortgages for higher-value properties.
Because conventional loans are offered by private lenders, requirements can vary depending on the lender, borrower, property, and specific loan program.
How Much Down Payment Do You Need for a Conventional Loan?
One common misconception is that conventional loans always require a 20% down payment. In reality, some conventional mortgage programs allow qualified borrowers to purchase a home with a significantly smaller down payment.
Depending on the loan program and borrower qualifications, down payments can potentially be as low as 3%.
A larger down payment can have advantages, including reducing the amount you borrow and potentially lowering your monthly payment. Putting 20% or more down may also allow you to avoid private mortgage insurance on many conventional loans.
However, the best down payment amount depends on your financial situation. Using all of your savings for a down payment may leave less money available for closing costs, emergencies, repairs, and other expenses.
Conventional Loan Credit Requirements
Credit is an important factor when applying for a conventional mortgage. Lenders generally review your credit history and credit score along with income, employment, debt, assets, and other financial information.
Conventional loans can be particularly attractive to borrowers with strong credit because better credit profiles may help borrowers qualify for more favorable interest rates and terms.
However, there is no single credit score that guarantees approval. Each lender and loan program may have different requirements, and other factors can influence the final decision.
Before applying, reviewing your credit reports and addressing potential errors or outstanding debts may help you prepare for the mortgage application process.
What Is PMI on a Conventional Loan?
One of the key features of conventional loans is private mortgage insurance (PMI).
If you make a down payment of less than 20% on many conventional mortgages, your lender may require PMI. PMI protects the lender—not the homeowner—if the borrower stops making mortgage payments.
The cost of PMI can vary based on factors such as your loan amount, down payment, credit profile, and lender.
One potential advantage of conventional financing is that PMI may generally be removed once you meet applicable requirements and build sufficient equity in the home. This can make conventional loans appealing to borrowers who want to purchase with a smaller down payment while having a path toward eliminating mortgage insurance.
Fixed-Rate and Adjustable-Rate Conventional Mortgages
Conventional loans can come with different interest-rate structures.
A fixed-rate mortgage keeps the same interest rate for the life of the loan, meaning your principal and interest payment generally remains consistent. Common fixed-rate terms include 15-year and 30-year mortgages.
An adjustable-rate mortgage (ARM) has an interest rate that can change after an initial fixed-rate period according to the terms of the loan.
A fixed-rate mortgage may be appealing if you value predictable monthly payments, while an ARM may make sense for certain borrowers depending on their financial goals, expected time in the home, and market conditions.
Before selecting an ARM, it is important to understand how and when the interest rate can change and how those changes could affect future payments.
Benefits of Conventional Loans
Conventional financing can offer several advantages for qualified homebuyers:
- Low down payment options: Some programs allow down payments as low as 3%.
- Flexible property options: Conventional loans can be used for various eligible property types.
- Competitive rates: Borrowers with strong credit and financial profiles may qualify for competitive interest rates.
- Potential PMI cancellation: PMI may be removed when applicable requirements are met.
- Different loan terms: Borrowers can choose from various repayment structures and loan terms.
- Primary residence, second home, and investment options: Depending on the loan program, conventional financing may be available for different property purposes.
These benefits make conventional loans a popular choice for both first-time and experienced homebuyers.
Conventional Loans vs. FHA Loans
When comparing mortgage options, many borrowers consider conventional financing alongside FHA loans.
FHA loans are government-insured and can be helpful for borrowers who may have smaller down payments or less-than-perfect credit. Conventional loans, on the other hand, can be particularly appealing to borrowers with stronger credit and financial profiles.
The costs can also differ. FHA loans generally include FHA mortgage insurance, while conventional loans may require PMI when the down payment is below a certain level.
The right option depends on your credit, down payment, income, debt, property, and long-term financial goals. Comparing personalized Loan Estimates can help you determine which mortgage offers the best overall value.
Conventional Loans vs. VA Loans
Eligible veterans, active-duty service members, and certain surviving spouses may also have access to VA financing.
VA loans can offer benefits such as potential zero-down-payment financing and no monthly private mortgage insurance. Conventional loans, however, are available to a broader group of borrowers who meet the lender’s requirements.
If you qualify for a VA loan, it is worth comparing both options before making a decision. Factors such as your down payment, credit profile, funding fee, interest rate, closing costs, and long-term plans can affect which mortgage is most suitable.
What Are Conventional Loan Limits?
Many conventional mortgages are conforming loans that follow annual loan limits established for Fannie Mae and Freddie Mac. These limits can vary depending on the location and property type and may change from year to year.
If you are purchasing a higher-priced property, you may need to explore a jumbo or other non-conforming mortgage instead.
Understanding the applicable loan limit before beginning your home search can help you establish a realistic budget and avoid surprises during the mortgage process.
How to Apply for a Conventional Loan
Getting started with a conventional loan usually involves several steps.
First, review your credit, income, debts, savings, and monthly budget. Next, compare mortgage lenders and request information about available loan programs and rates.
After selecting a lender, you will generally provide financial documentation such as income information, employment details, bank statements, and information about your debts and assets.
Once you find a home and submit an offer, the lender will review the property and your financial information as part of the underwriting process. An appraisal may also be required to help determine the property’s value.
After the loan is approved and all conditions are satisfied, you can move toward closing and officially become a homeowner.
Is a Conventional Loan Right for You?
A conventional loan may be a good choice if you have a solid credit history, reliable income, manageable debt, and enough savings for your desired down payment and closing costs.
However, there is no single mortgage that is best for everyone. Your financial situation, home price, down payment, credit profile, and long-term plans should all be considered.
Before making a decision, compare the interest rate, monthly payment, PMI, closing costs, loan fees, and total cost of borrowing.
Explore Your Conventional Loan Options
Conventional Loans can provide flexible financing options for homebuyers who meet conventional mortgage requirements. With low-down-payment programs, different loan terms, and the potential to eliminate PMI as you build equity, conventional financing can be a strong option for many buyers.
If you’re planning to purchase a home, Richmond Home Lender can be a starting point for exploring mortgage financing options and learning more about the home-buying process.
Conventional loan requirements, loan limits, interest rates, PMI costs, and lender guidelines can change. Loan approval and terms depend on the borrower’s individual financial circumstances. Always confirm current requirements and costs with your mortgage lender before making a financing decision.