A conventional loan is a type of mortgage that is not insured or guaranteed by any government agency. Instead, these loans are offered by private lenders, such as banks, credit unions, or mortgage companies, and adhere to guidelines set by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. This makes them distinct from government-backed loans like FHA, VA, or USDA loans. Conventional loans are widely used by borrowers because they often offer competitive terms for those who meet the qualifications. Let’s go over what is a conventional loan.
Key Features of a Conventional Loan
Conventional loans come with several defining features. These include:
- Private Mortgage Insurance (PMI): Borrowers who cannot make a down payment of at least 20% are usually required to pay for PMI. This insurance protects the lender in case of default but can be removed once the borrower achieves 20% equity in the home.
- Loan Limits: Conventional loans have limits set annually by the Federal Housing Finance Agency (FHFA). In most areas, the baseline limit for a single-family home is $726,200 as of 2025. However, limits can be higher in areas with high property values.
- Fixed and Adjustable Rates: Borrowers can choose between a fixed-rate loan, where the interest rate remains the same throughout the life of the loan, or an adjustable-rate mortgage (ARM), where the interest rate fluctuates after an initial fixed period.
- Flexible Terms: Conventional loans typically offer term lengths of 10, 15, 20, or 30 years, giving borrowers a range of repayment options.
Who Qualifies for a Conventional Loan?
Qualifying for a conventional loan often requires a stronger financial profile compared to government-backed loans. Lenders assess a variety of factors to determine eligibility, including:
- Credit Score: Most lenders require a credit score of at least 620, although higher scores often qualify for better interest rates.
- Debt-to-Income Ratio (DTI): The DTI ratio, which compares monthly debt payments to gross monthly income, typically must not exceed 43%, though some lenders allow higher ratios for well-qualified borrowers.
- Down Payment: A minimum down payment of 3% is required for some conventional loan programs, but putting down 20% eliminates the need for PMI.
- Employment History: Lenders usually require at least two years of stable employment or consistent income.
- Assets and Savings: Proof of sufficient savings for the down payment, closing costs, and cash reserves is often necessary.
Types of Conventional Loans
There are two main types of conventional loans: conforming and non-conforming.
Conforming Loans
Conforming loans meet the standards set by Fannie Mae and Freddie Mac. These standards include loan limits, borrower qualifications, and property requirements. Conforming loans are widely available and often offer lower interest rates due to their lower risk for lenders.
Non-Conforming Loans
Non-conforming loans, often called jumbo loans, exceed the conforming loan limits set by the FHFA. These loans are used to finance high-value properties and come with stricter credit and financial requirements. Since they are not backed by Fannie Mae or Freddie Mac, non-conforming loans may have higher interest rates.
Benefits of a Conventional Loan
Conventional loans offer several advantages, making them a popular choice for many borrowers:
- Competitive Interest Rates: For borrowers with good credit, conventional loans often offer lower interest rates compared to government-backed options.
- Flexible Use: Conventional loans can be used to finance various types of properties, including primary residences, second homes, and investment properties.
- No Upfront Insurance Fees: Unlike FHA loans, conventional loans do not require upfront mortgage insurance premiums.
- Removal of PMI: Borrowers who pay down their loan to 80% of the home’s value can request PMI removal, reducing their monthly payments.
- Higher Loan Limits for Certain Areas: In high-cost areas, conforming loan limits are adjusted upward to accommodate the market.
Drawbacks of a Conventional Loan
While conventional loans have many benefits, they may not be suitable for all borrowers. Potential drawbacks include:
- Stricter Requirements: The eligibility criteria for conventional loans are often more stringent than those for government-backed loans.
- PMI Costs: Borrowers who cannot make a 20% down payment must pay for PMI, increasing the cost of the loan.
- Credit Score Sensitivity: Interest rates and terms are heavily influenced by the borrower’s credit score, making them less advantageous for those with lower scores.
- Limited Support for Low-Income Borrowers: Government-backed loans often provide more assistance for borrowers with low incomes or poor credit.
Comparing Conventional Loans to Government-Backed Loans
Conventional loans differ significantly from FHA, VA, and USDA loans in terms of eligibility, costs, and benefits.
Conventional vs. FHA Loans
FHA loans, backed by the Federal Housing Administration, are geared toward borrowers with lower credit scores or smaller down payments. While FHA loans require mortgage insurance for the life of the loan, conventional loans allow for PMI removal once sufficient equity is built.
Conventional vs. VA Loans
VA loans, available to eligible veterans and active-duty military members, offer no down payment and no mortgage insurance. While they provide significant benefits, they are only available to those who qualify. Conventional loans are more widely accessible but require higher upfront costs.
Conventional vs. USDA Loans
USDA loans are designed for low- to moderate-income borrowers in rural areas. They offer no down payment but come with income and location restrictions. Conventional loans provide greater flexibility in terms of property location and borrower qualifications.
When is a Conventional Loan the Right Choice?
A conventional loan may be the best option for borrowers who:
- Have a strong credit history and financial profile.
- Can afford a significant down payment to avoid PMI.
- Are purchasing a property that meets conforming loan limits.
- Prefer flexibility in loan terms and property use.
Conversely, borrowers with lower credit scores or limited funds for a down payment may benefit more from government-backed loan options.
How to Apply for a Conventional Loan
Applying for a conventional loan involves several steps:
- Assess Your Finances: Review your credit score, savings, and income to determine your eligibility.
- Get Pre-Approved: Obtain pre-approval from a lender to understand your borrowing capacity and strengthen your offer when shopping for a home.
- Shop for a Lender: Compare loan terms, interest rates, and fees from multiple lenders to find the best fit.
- Provide Documentation: Submit necessary documents, such as proof of income, tax returns, and bank statements, to support your application.
- Close the Loan: Once approved, review the loan terms, sign the paperwork, and finalize the purchase or refinance.
Tips for Success with a Conventional Loan
To make the most of a conventional loan, consider the following strategies:
- Improve Your Credit Score: Higher scores lead to better terms and lower interest rates.
- Save for a Larger Down Payment: Putting down 20% eliminates PMI and reduces overall costs.
- Shop Around: Comparing offers from multiple lenders ensures you get the best deal.
- Understand Loan Terms: Review the terms, fees, and repayment conditions carefully to avoid surprises.
- Work with a Trusted Lender: A reputable lender can guide you through the process and help you secure favorable terms.
Conclusion
Conventional loans are a versatile and widely used financing option that can accommodate a variety of borrower needs. Whether you’re purchasing your first home, upgrading to a larger property, or investing in real estate, a conventional loan offers competitive terms and flexibility for those who qualify.
While the stricter requirements and potential for PMI may deter some borrowers, the benefits of lower interest rates, flexibility, and the ability to remove PMI make conventional loans an attractive choice. By understanding the features, benefits, and qualifications, you can determine if a conventional loan aligns with your financial goals.
At Float Finance, we specialize in helping borrowers navigate the complexities of boat loans and yacht loans. Whether you’re ready to apply or need assistance exploring your options, our team is here to provide expert guidance every step of the way.