Conventional mortgages are the most popular home loans sold in the U.S. They’re designed to meet the needs of many types of homebuyers. This article covers types of conventional loans, how to qualify, and differences between conventional and government loans.
[Read: Best Mortgage Lenders]
What Is a Conventional Loan?
A conventional loan is a mortgage that’s not backed by the federal government — unlike FHA, VA and USDA home loans. Conventional loans are not insured by a government agency. Instead, they’re funded by private lenders and insured, when necessary, by private mortgage insurance companies.
Conventional loans fall into two categories: conforming and nonconforming.
— A conforming loan meets guidelines established by Fannie Mae or Freddie Mac. Fannie and Freddie are government-backed housing finance giants that buy mortgages from lenders and sell them to investors.
— Nonconforming loans are mortgages that don’t meet conforming guidelines. Lenders are free to create their own underwriting rules as long as they don’t violate lending laws. They may choose to keep these loans on their own books or sell them to investors through various channels.
[See: Best Mortgage Lenders for First-Time Homebuyers]
How a Conventional Loan Works
Conventional loans vary a lot in their underwriting requirements and their terms. So it’s helpful to prequalify with lenders first if you’re unsure of the type of loan you want or if you qualify. Your loan officer or processor takes your information and usually submits it through an automated underwriting service, or AUS. The AUS makes an underwriting decision and generates a list of requirements for you to meet (like supplying pay stubs and bank statements and lining up homeowners insurance). Once a human underwriter signs off, you get loan documents to sign and are cleared to close.
Beyond the Standard Mortgage: Conventional Loan Types for Unique Financial Situations
You’ll probably see many types of conventional loans when you shop for a mortgage. Here are some of the most common.
Conforming Loan
Conforming loans are what many people think of when they hear the term “conventional mortgage,” and many use the terms interchangeably. Conforming loans get their names because they must conform to guidelines set by Fannie Mae and Freddie Mac. This allows investors to be confident that any loan they buy has the same low risk of default.
Qualified Mortgage
Qualified mortgage is a designation that applies to loans that do not have risky features, high rates or fees, and the lender must verify the borrower’s income and assets to make sure the loan is affordable. Government-backed loans are qualified mortgages, and many conforming loans are QM — but not all.
Nonconforming Loan
Nonconforming loans include all loans that are not government-backed loans or conforming loans. Mortgages can be nonconforming for many reasons, and they all fall under this big umbrella.
Jumbo Loan
Loans that exceed the maximum amount for conforming loans are often called “jumbo” mortgages. Really large loans may be called “super jumbo” mortgages. Maximum loan amounts for conforming mortgages vary by location, so the line between jumbo and conforming depends on where you are. Jumbo loans can be harder to qualify for because there is more money involved, and that makes them riskier for lenders.
Nonprime Loan
Nonprime is the preferred term for what was formerly called subprime loans. The most typical reason for a loan being nonprime is that it accepts lower credit scores — often under 580. But there are other reasons for being nonprime. You may have a recent bankruptcy or foreclosure that would require you to wait for years before getting a government or conforming mortgage. Or you might need a nonprime loan because your income can’t easily be proven with tax returns, but it shows up on your bank statements. Note that down payments are higher for nonprime financing.
Alt-A Loan
These are loans that require alternative ways of verifying income. Borrowers must usually have excellent credit.
Portfolio Loan
This is a loan that a mortgage lender chooses to keep on its own books and not sell to investors. While portfolio loans tend to be nonconforming, they can also be conforming loans.
Non-QM Loan
These conventional loans don’t meet the requirements for qualified mortgages. They may have riskier features, like balloon payments, negative amortization or interest-only payments.
[See: Best Low- and No-Down-Payment Mortgages]
Conventional vs. Government Loans: FHA, VA, and USDA Differences
Your financial profile can help you determine which mortgage is the best fit for you.
Overall, consumers may prefer conventional loans over government-backed loans — which include Federal Housing Administration loans, Veterans Affairs loans and U.S. Department of Agriculture loans — because federal loans have additional restrictions and requirements, says Andrew Ragusa, licensed real estate broker and owner of REMI Realty in East Northport, New York. “A conventional loan removes those concerns,” he says.
Financial Guidelines Required to Qualify for a Conventional Home Loan
Conventional loan requirements depend on the type of loan you choose.
— Down payments for conforming loans can be as low as 3%. If you’re looking for a jumbo or super jumbo loan, expect the down payment requirement to be higher — at least 10% (although some lenders make 95% jumbo loans to highly qualified applicants).
— A credit score of at least 620. If you’re getting a jumbo loan, the requirement will be higher — usually at least 680.
— A debt-to-income ratio of 45%. This means that, in general, no more than 45% of your total monthly gross pay should go toward debt payments. If you have a large down payment, some lenders allow higher ratios.
— Proof of income. For conforming loans, you will likely need two years of documentation, including tax returns, W-2 forms or recent pay stubs, to show that you have ample, steady income to afford the loan payments. Nonconforming lenders may allow alternative income documentation.
Mortgage underwriting begins once you apply for the lender to determine the risk of offering you a loan. You may be asked for additional documentation about your finances along the way.
In the meantime, the lender will appraise the property to determine its value. You may also schedule a home inspection to identify any major problems before closing.
Advantages and Disadvantages of Conventional Loans
Conventional loans come with many benefits to borrowers and some downsides. Here’s a closer look at some pros and cons of conventional loans:
Pros
— Competitive interest rates.
— Low down payments. You can get a conventional loan with as little as 3% down, Ragusa says.
— PMI premiums can eventually be canceled on conforming loans. Once you’ve paid down 78% of your home’s original value, your loan servicer must remove your PMI.
— Can be used for all types of properties. Conventional loans can be used for a primary residence, vacation home or rental property, unlike government-backed loans, which are limited to principal residences.
Cons
— Tougher credit score requirements than for government loan programs. Conventional loans often require a credit score of at least 620, which leaves out some homebuyers.
— More stringent DTI requirements. Conventional loans typically demand higher DTIs than government programs do. Expect to meet a standard of no more than 45% DTI.
— PMI premiums with a low down payment on conforming loans. You’ll still have to pay PMI if you put down less than 20%.
If you’re not sure whether a conventional loan is the right move, your real estate agent and loan officer can help, Ragusa says. They will be able to guide you to the most appropriate loan based on your financial situation and credit history.
“There’s a reason all the other loans exist,” Ragusa says. If your finances and the property meet the qualifications for a conventional loan, though, it can be a great choice.
When to Choose Conventional Over a Government Loan
A conventional loan can be a good choice, depending on your financial situation. Conventional loans are widely available and easy to shop for. Interest rates can be very competitive. They may not be the best solution if your situation is “out-of-the-box” or if you’re likely to be penalized for down payment, income or credit challenges. Here are some scenarios in which a government-backed loan might be a better fit:
— Your debt-to-income ratio is over 43%.
— You don’t have money for a down payment.
— You qualify for VA financing for service members and veterans.
— You want an assumable loan. Government-backed loans can be assumed by qualifying buyers.
— Your credit score is below 620.
On the other hand, conventional loans comprise a variety of programs. Here’s where they shine:
— Your situation is typical — 5% to 20% down, good to excellent credit, wage income, and a debt-to-income ratio of 43% or lower. Your application will likely be underwritten quickly.
— You want a very large loan that exceeds the limits of government-backed mortgages.
— You have credit problems and need a nonprime loan. Expect to make a large down payment.
— You want to buy investment or vacation property.
— You want to purchase an unusual property that doesn’t meet government loan requirements.
— You have very high credit scores and a small down payment. Private mortgage insurance, required for most conventional loans with down payments under 20%, will be much cheaper for you than premiums for government-backed loans.
Conventional financing, unlike government-backed loans, does not have geographic limitations or special requirements. A conventional loan can be more flexible than a government-insured loan, but harder to qualify for.
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What Is a Conventional Loan and How Does It Work? originally appeared on usnews.com
Update 06/05/26: This story was published at an earlier date and has been updated with new information.
