What is a Conventional Loan



When you think of a traditional mortgage, a conventional loan is probably what comes to mind.

Conventional loans are the most popular type of mortgage loan used to purchase a home.

In this article, we will cover conventional loan requirements, loan limits, rates, and see how they compare to government home loans.

Conventional Loan Rates (Novermber 2020)

Loan Term

Interest rate

APR

30-year fixed-rate mortgage

 2.850%

2.985%

15-year fixed-rate mortgage

2.760%

2.825%

5/1 adjustable-rate mortgage

3.025%

3.195%

What is a Conventional Loan?

A conventional loan is a mortgage that is not backed by the Federal Government, but by private mortgage insurance companies. They are offered by private lenders and meet the Fannie Mae and Freddie Mac conforming loan requirements and guidelines. They require at least a 620 credit score and a down payment between 3% – 20% of the purchase price.

2020 Conventional Loan Requirements

• Minimum 620 credit score

• 3% - 20% down payment

• 36-48 month waiting period after a bankruptcy or foreclosure

• Maximum 43% debt-to-income ratio

• Two years of stable employment history

• Proof of income (W2's, tax returns)

Complete conventional loan requirements and guidelines

Types of Conventional Loans

Conventional Loan

A traditional conventional loan requiring 5% - 20% down, 640 credit score, PMI only required if the loan-to-value ratio (LTV ratio) is above 80%.

Conventional 97 Loan

A conventional 97 loan requires just a 3% down payment, which is even lower than FHA (3.5%). Borrowers must have a 680 credit score and be buying their primary residence to be eligible.

Piggyback Mortgage

A piggyback loan is a creative way to get a conventional home loan with no PMI while putting less than 20% down. Instead of getting one loan for 80% of the purchase price which would require a 20% down payment, you will get a separate loan for 10% LTV, leaving you just needing to put 10% down and avoiding mortgage insurance.

HomeReady loan

Fannie Mae created their HomeReady loan program to help low-to-moderate income families in low-income, minority, and disaster-impacted communities

Home Possible loan

Freddie Mac's Home Possible loan is very similar to the HomeReady loan program. It's designed for low-to-median-income borrowers, move-up, and first-time homebuyers.

Down Payment Requirements

A common misconception is that all conventional loans require a 20% down payment, however, that is not the case.

You can get a conventional loan with as little as 3% down, private mortgage insurance (PMI) will be required. If you don’t want to be required to carry PMI, you will need 20% down.

In order to compete with Government loans, such as FHA loans, there are a number of conventional loan programs designed for first-time homebuyers, or anyone that does not have the funds for a large down payment.

Conventional Loan Down Payment Guidelines

• Down payment between 3%-20%

• Mortgage insurance required if down payment is less than 20%

• Can be a gift from a friend or family member

• Down payment can come from savings, 401k, or investment accounts

• Cannot use a loan

Conventional Loan Rates

Interest rates on conventional loans are currently at historic lows. The average interest rate on a 30-year fixed-rate loan is under 3.0%. This is exceptional considering that just 10 years conventional loan interest rates were above 6%.

The mortgage rate will vary based on several different factors. Your credit score has the biggest impact on the rate. The loan term also plays a role in your rate, the shorter the term, the lower your rate will be. Interest rates also vary by lender so it’s important that you shop loan estimates with multiple lenders.

Conventional Loan Rates (Novermber 2020)

Loan Term

Interest rate

APR

30-year fixed-rate mortgage

 2.850%

2.985%

15-year fixed-rate mortgage

2.760%

2.825%

5/1 adjustable-rate mortgage

3.025%

3.195%

Advertised interest rates from lenders are based on an ideal borrower with perfect credit, so unless you have a 750 credit score you can expect a higher rate. Be sure to apply with mortgage lenders to get a rate quote based on your situation.

Conventional Loan Limits

Conventional loans have higher loan limits than government mortgage loans. Depending on where you live the maximum loan amount is between $510,400 – $765,600. If you need a loan that exceeds the conventional loan limit you will need a nonconforming loan such as a jumbo loan.

2020 Conventional Loan Limits

# of units

Low-cost area limit

High-cost area limit

1-Unit

$510,400

$765,600

2-Unit

$653,550

$980,325

3-Unit

$789,950

$1,184,925

4-Unit

$981,700

$1,472,550

How to Qualify for a Conventional Loan

Some people mistakenly believe that conventional loans are incredibly hard to qualify for. In reality, besides the higher credit requirement, they aren’t any more difficult to qualify for than government-backed loans, like FHA or VA.

Like with any type of mortgage, you need to be able to prove you are capable to make the monthly payments.

Lenders will look at a variety of factors to determine whether or not a borrower qualifies.

Credit

Conventional loans do have higher credit score requirements than FHA loans. To qualify for a conventional mortgage, you’ll need at least a 620 FICO score.

A mortgage lender looks at your entire credit history, not just your credit score to determine your eligibility. If you have multiple collection accounts or late payments you may get denied a loan despite meeting the minimum score requirement.

Conventional Loan Credit Requirements

• Minimum 620 credit score

 43% maximum debt-to-income ratio

• No mortgage late payments in the last 6 months

• 48 month waiting period after a bankruptcy or foreclosure

• No judgments or liens

• Student loans included in DTI ratio unless on deferred payments

Income

Lenders will only give a loan to borrowers who can prove they have a reliable income that is sufficient for the loan amount they are seeking. You may be able to use other types of income such as child support, alimony, seasonal, and part-time employment.

You must be able to prove your income with the following documents.

Conventional Loan Income & Employment Requirements

• 1-2 months of Paystubs

• Two years of W2's and tax returns

• Proof of degree for new graduates

• Three months of bank statements

• Proof of seasonal, or part-time income

Employment

Two years of stable employment history is required for all types of home loans. You don’t need need to be at the same employer for two years as long as you stay in the same field.

Self-employed borrowers need to provide two years’ worth of tax returns to prove income. Lenders take the two-year total income and divide it by two to come up with your average income to base the maximum loan amount you will receive.

Conventional Loan Income & Employment Requirements

• 1-2 months of Paystubs

• Two years of W2's and tax returns

• Proof of degree for new graduates

• Three months of bank statements

• Proof of seasonal, or part-time income

Debt-to-Income

The maximum debt-to-income ratio (DTI) ratio allowed for conventional loans is 43%.

Your DTI ratio is the amount of your income that goes towards monthly debt obligations such as auto loans, credit cards, and mortgage payments.

Example: If your income is $5,000 per month and your total monthly payments are $2,000, your debt-to-income ratio is 40%.

Closing Costs

Closing costs are fees charged by mortgage lenders for processing and issuing a loan.

A home appraisal, origination fees, and title insurance are some of the items included. On average, closing costs amount to 2%-5% of the loan amount.

With conventional loans, sellers are allowed to cover a portion of the closing costs for the buyer

Private Mortgage Insurance

Conventional loans don’t require private mortgage insurance (PMI) with at least 20% down.

If you have less than a 20% down payment PMI will be required until the loan-to-value ratio hits 78%, at which point PMI will be canceled.

This is unlike government loans such as FHA and USDA loans which require mortgage insurance regardless of the down payment amount. If putting less than 10% down on an FHA loan, mortgage insurance will be required for the life of the loan.

Conventional loans also do not have up-front mortgage insurance that government-backed loans require.

Use our calculator to see how much home you can afford after factoring in PMI, property taxes, and homeowners’ insurance.

Eligible Property Types

A great benefit of conventional mortgages is that they are available on many types of properties.

Home Inspection Checklist

Foundation

Ensure that the foundation is stable. No cracks in the foundation and walls.

Drainage

Check that water is flowing away from the foundation.

Roof

Is the roof in good condition,with several more years left before it needs replacing. Asphalt shingles have a lifespan of 15-40 years.

Exterior

The exterior of the home should be in good condition. There should be no rotting wood, cracks in the brick, worn out weather seals.

Interior

Check the ceilings, walls, doors, and baseboards. Is everything in acceptable order for you.

Electrical

All electrical outlets and lights must function properly. 

Water sprinklers

If the property has a sprinkler system installed all zones must be tested to ensure functionability.

Air conditioning and heater

Heating and air condition systems must be inspected to ensure they are completely operational.

Appliances

All home appliances must be tested to ensure they work properly.

Odor

If the home smells, people assume it was the previous owners, not the smell of the house itself. Make sure all areas of the home are dry, and nothing is leaking. Wet areas can cause musty smells.

Termite Inspection

 Interior and exterior of the home should be inspected for termites. Existing termite treatment systems should be checked.

Mold Inspection

The home must be 100% free of mold.

Water Heater

Water heater must be tested to ensure it is functioning properly. 

FHA vs. Conventional Loans

Whether you should get an FHA loan or a conventional loan depends on your situation. If you have limited savings and credit issues then an FHA loan may be the best loan option. However, if you have a lot in savings and good credit then a conventional loan may be a better fit.

FHA Loans

Conventional Loans

Credit Score

500 with 10% down
580 with 3.5% down

620

Down Payment

10% down with 500 score
3.5% down with 580 score

3%-20%

Mortgage Insurance

Up-front MIP payment Monthly MIP payments

>10% down MIP cancels in 11 yrs 
<10% down MIP required for life of the loan

Monthly PMI payments

PMI is canceled when LTV ratio reaches 78%

Loan Limits

Low-cost area - $331,760
High-cost area - $765,600

Low-cost area - $510,400
High-cost area - $765,600

Debt-to-Income

43% - 50% max DTI depending on the lender

Max 43% DTI

Residence Type

Primary residence only

Primary residence
Second home
Vacation home
Investment property

You should also speak to a loan officer to compare FHA vs conventional loans to determine which one is most beneficial for you.

Conventional Loan Pros and Cons

Pros

Cons

  • Adjustable-rate and fixed-rate loan terms available

  • Higher credit requirements than FHA

  • No private mortgage insurance (PMI) with 80% loan-to-value ratio

  • Borrower requirements are more strict

  • Low interest rates

  • Debt-to-income ratio under 43%

  • Available for second homes and investment properties

  • 36 month waiting period after a bankruptcy or foreclosure

  • Down payment can be a gift

  • Fixed and adjustable-rate loan options

      • Lower PMI rates than FHA

      • Conventional 97 with 3% down

      Conforming vs. Non-Conforming Loans

      The difference between conforming and non-conforming loans is that conforming loans adhere to the standards set by Fannie Mae and Freddie Mac, the two largest buyers of conventional mortgage loans in the country.

      Non-conforming loans are loans that do not meet these standards and therefore are not sold to Fannie Mae and Freddie Mac, but to investors. Jumbo loans and portfolio loans are examples of non-conforming loans.

      Conventional Loan Alternatives

      If you find you’re not eligible for a conventional mortgage there are alternatives that are easier to qualify for. Government-backed loans are issued by private lenders and guaranteed by the Government, they have low down payment and credit requirements.

        • FHA Loans – An FHA loan is popular with first-time buyers for its low 580 credit score requirements and 3.5% down payment. Some lenders may be able to approve borrowers with a 500 credit score with 10% down.
        • VA Loans – a VA loan is for Veterans; they come with no downpayment or mortgage insurance. Credit score requirements vary by lender. Many lenders require a 620+ credit score for a VA loan, but some lenders are able to go down as low as 500.
        • USDA Loans – The Department of US Agriculture created the USDA loan program for low-to-median income homebuyers in rural areas of the country. Because they offer 100% financing a higher credit score of 640 is typically required.

      A conventional loan may be a good fit for you if:

      • If you have a 620 credit score
      • Want to avoid PMI by putting at least 20% down
      • Have a high income (low debt-to-income ratio)
      • Refinance out of an FHA loan into conventional to drop PMI
      • Need a loan amount above the FHA loan limit

       

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