2021 Conventional Loan Guide


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 other mortgage loans.

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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.

2021 Conventional Loan Requirements

Conventional loan requirements and guidelines

Types of Conventional Loans

Traditional Conventional Loan

A traditional home loan requiring a 5% – 20% down payment and a 620 credit score. Mortgage insurance is only required if the loan-to-value ratio (LTV ratio) is above 80%.

  • Minimum 620 credit score
  • 5%-20% down payment
  • 43% maximum debt-to-income ratio

 

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 buying the property as their primary residence to be eligible.

  • 680+ credit scores
  • 3% down payment
  • 43% maximum DTI ratio
  • Only for primary residences

 

HomeReady and Home Possible Loans

Fannie Mae and Freddie Mac created the 3% down payment loan programs, HomeReady and Home Possible to help low-to-moderate income families became homeowners for the first time. The down payment can be a gift from a friend or family member. Borrowers must be first-time homebuyers, have at least a 620 credit score, and have a household income that does not exceed 100% of the area median income.

  • Only first-time homebuyers are eligible
  • Minimum 620 credit score
  • 50% maximum debt-to-income ratio
  • Income limits – 100% of the area median income
  • For primary residences only

 

Piggyback Loan

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.

  • 680+ credit score
  • 2 separate loans – one for 80% / one for 10% of purchase price
  • 10% down payment

 

Down Payment Requirements

A common misconception is that home loans require a 20% down payment, however, that is not the case. You can get a conventional mortgage 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.

  • Down payment between 3%-20%
  • Mortgage insurance required if the 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 Limits

Conventional loans have higher loan limits than government mortgage loans. If you need a loan that exceeds the conforming loan limit you will need a nonconforming loan such as a jumbo loan.

2021 Conventional Loan Limits

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.

  • Minimum 620 credit score
  • 43% maximum debt-to-income ratio
  • No mortgage late payments in the last 6 months
  • 36 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.

Show proof of income with the following documents:

  • 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.

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. On average, closing costs amount to 2%-5% of the loan amount.

A home appraisal, origination fees, and title insurance are some of the items included. 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 upfront 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.

  • Single-Family Homes
  • Second homes and investment properties
  • Condos and townhomes
  • Rehab properties
  • Multi-unit properties
  • Planned unit developments (PUDs)

 

Conventional Loan Rates

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 multiple lenders.

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Conventional Loans vs. FHA 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.

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

Pros and Cons of Conventional Mortgages

Pros


Cons

  • Adjustable-rate and fixed-rate loan terms available

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

  • Low interest rates

  • Available for second homes and investment properties

  • Down payment can be a gift

  • Fixed and adjustable-rate loan options

  • Lower mortgage insurance rates than FHA

  • Conventional loan programs requiring 3% down

  • Higher credit requirements than FHA

  • Borrower requirements are more strict

  • Debt-to-income ratio under 43%

  • 36 month waiting period after a bankruptcy or foreclosure

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.
  • 203k Loans – An FHA 203k loan provides financing to buy a home plus additional funds to make home improvements and repairs.

 

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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