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A Guide to Conventional Loans
Conventional loans are the most popular type of mortgage used to finance home purchases. These loans are favored by borrowers with good credit and stable finances because they offer competitive interest rates and flexible terms.
Unlike government-backed loans such as FHA, VA, or USDA loans, conventional loans are funded by private lenders and not insured by the federal government.
This guide covers everything you need to know about conventional loans, including requirements, loan limits, benefits, and how they compare to other mortgage options.
Whether you’re a first-time homebuyer or refinancing, understanding conventional loans will help you make the best decision.
What is a Conventional Loan?
A conventional loan is a type of mortgage that is not insured or guaranteed by any government agency. Instead, it’s backed by private mortgage insurance companies.
These loans adhere to guidelines set by Fannie Mae and Freddie Mac, commonly referred to as conforming loans. However, some conventional loans, like jumbo loans, exceed the loan limits and are considered non-conforming.
“Conventional loans remain a top choice for buyers with good credit and stable finances. They offer flexibility in terms and are often available at competitive rates,” says Jessica Turner, Senior Loan Officer at Prestige Home Lending.
Key Benefits of Conventional Loans:
- No Private Mortgage Insurance (PMI): If you can put down at least 20% of the home’s purchase price, you can avoid PMI altogether.
- Available for Primary, Secondary, and Investment Properties: Unlike government loans, conventional loans can be used to purchase second homes and investment properties.
- Higher Loan Limits: Conventional loans have higher loan limits compared to government-backed loans, making them a better choice for those looking to finance more expensive homes.
- Flexible Down Payment Options: Down payments for conventional loans start as low as 3%, making them accessible for first-time homebuyers.
Conventional Loan Requirements for 2024
The requirements for a conventional loan include several factors such as credit score, income, and employment history. Below is a breakdown of what lenders typically look for:
Credit Score Requirements
The minimum credit score for a conventional loan is 620. However, higher credit scores are often required for certain loan types:
- Traditional Conventional Loan: Minimum 620 credit score.
- Conventional 97 Loan: Minimum 680 credit score.
- HomeReady and Home Possible: Minimum 620 credit score.
- Piggyback Loan: Minimum 680 credit score.
Debt-to-Income Ratio (DTI)
Conventional loans generally require a DTI ratio of 43% or less. This means that no more than 43% of your monthly income should go towards paying off debt, including your new mortgage payment. In some cases, a higher DTI ratio may be accepted with compensating factors like a larger down payment.
Income and Employment
Lenders want to see a stable income and employment history, typically requiring two years of consistent employment. Self-employed borrowers must provide two years of tax returns to verify their income. Other income sources such as child support or rental income may also be considered if they meet specific requirements.
“Consistency is key when it comes to income. Lenders are more likely to approve a loan when they see a borrower has a stable employment history, especially for self-employed individuals,” notes Thomas Bradley, Mortgage Specialist at Reliable Financial Group.
Down Payment Requirements
Down payments for conventional loans can vary from 3% to 20%, depending on the loan type and the borrower’s financial situation:
- Standard Conventional Loan: 5%-20% down payment.
- Conventional 97 Loan: 3% down payment.
- HomeReady and Home Possible: 3% down payment with income restrictions.
- Piggyback Loan: 10% down payment.
Loan Limits for Conventional Loans in 2024
Conventional loans have specific loan limits that are set annually and vary by location. These loan limits determine the maximum loan amount you can borrow without resorting to non-conforming or jumbo loans. For 2024:
- Standard Loan Limit: $766,500 in most areas.
- High-Cost Area Loan Limit: Up to $1,089,300.
If you need a loan amount above these limits, you will need a non-conforming loan, such as a jumbo loan.
Conventional Loan Limits by State (2024)
| State | Loan Limit |
|---|---|
| Texas | $766,500 |
| California | $1,089,300 |
| Florida | $766,500 |
| New York | $1,089,300 |
Types of Conventional Loans
There are several types of conventional loans, each with its own benefits and eligibility criteria:
Traditional Conventional Loan
- Minimum 620 credit score.
- 5% – 20% down payment.
- 43% maximum DTI ratio.
Conventional 97 Loan
This loan program requires just a 3% down payment, making it even more accessible for first-time homebuyers.
- Minimum 680 credit score.
- 3% down payment.
- Primary residences only.
HomeReady and Home Possible Loans
These programs are designed for low-to-moderate-income borrowers and allow for as little as a 3% down payment.
- Minimum 620 credit score.
- Income limits: 100% of the area median income.
- Available for primary residences only.
Piggyback Loan
A piggyback loan involves taking out two separate loans simultaneously to avoid PMI.
- Minimum 680 credit score.
- Two loans (80% and 10% LTV).
- 10% down payment.
How to Qualify for a Conventional Loan
Qualifying for a conventional loan is similar to other types of mortgages but with stricter requirements. Here’s how you can improve your chances:
- Improve Your Credit Score: Work on paying off existing debts and avoid late payments.
- Save for a Larger Down Payment: A 20% down payment can help you avoid PMI.
- Reduce Your Debt-to-Income Ratio: Paying off debts and increasing your income can lower your DTI ratio.
- Organize Financial Documents: Gather all necessary documents such as pay stubs, bank statements, and tax returns.
Closing Costs and PMI
Closing costs for conventional loans typically range from 2% to 5% of the loan amount. Sellers are allowed to cover a portion of these costs if negotiated during the sale.
Private Mortgage Insurance (PMI)
PMI is required for conventional loans with less than a 20% down payment. Unlike FHA loans, PMI can be removed once your loan-to-value (LTV) ratio reaches 78%.
Conventional Loan Rates
Interest rates for conventional loans are influenced by your credit score, loan amount, and current market conditions. As of 2024, the average rate for a 30-year fixed conventional loan is around 6.5%.
Pros and Cons of Conventional Loans
Pros:
- No PMI with a 20% down payment.
- Available for primary, secondary, and investment properties.
- Flexible loan terms (10, 15, 20, or 30 years).
- Higher loan limits than FHA and VA loans.
Cons:
- Stricter credit and income requirements.
- Higher down payments needed to avoid PMI.
- Maximum DTI ratio of 43%.
Frequently Asked Questions
What is the minimum credit score for a conventional loan?
The minimum credit score for a conventional loan is 620. However, specialized loan programs like the Conventional 97 loan require a 680 score or higher.
What are the down payment requirements for a conventional loan?
Down payments range from 3% to 20%, depending on the loan type and your financial profile.
Can I use gift funds for a down payment?
Yes, you can use gift funds for a down payment, but proper documentation is required.
How does a conventional loan compare to FHA and VA loans?
Conventional loans are more flexible and have higher loan limits but come with stricter eligibility criteria.
Can I qualify for a conventional loan after bankruptcy?
Yes, but there is typically a waiting period of 36 months after a bankruptcy or foreclosure.
What property types are eligible for conventional loans?
Conventional loans can be used for single-family homes, condos, multi-unit properties, and more.
How do I qualify for a conventional loan?
Improve your credit score, lower your DTI ratio, and save for a larger down payment to boost your chances.