What is a Conventional Loan?: Everything You Must Know

If you’re looking to buy a home or make a big purchase, chances are you’ve come across the term “conventional loan”. But what exactly is a conventional loan? In this article, we’ll explore what conventional loans are, the different types of conventional loans, and everything you need to know before applying for one.

What is a Conventional Loan?

A conventional loan is a type of mortgage that is not backed by a government agency such as the Federal Housing Administration (FHA), the Veterans Administration (VA), or the US Department of Agriculture (USDA). Instead, conventional loans are funded by private lenders such as banks, credit unions, and mortgage companies.

Since conventional loans are not backed by a government agency, they typically have stricter eligibility requirements than government-backed loans. Borrowers need to have good credit scores, low debt-to-income ratios, and a sizable down payment to qualify for a conventional loan.

Types of Conventional Loans

There are two types of conventional loans: conforming and non-conforming.

Conforming Loans

Conforming loans are loans that conform to the guidelines set by Fannie Mae and Freddie Mac, two government-sponsored enterprises (GSEs) that purchase mortgages from lenders. These guidelines include limits on loan amounts, borrower credit scores, and debt-to-income ratios.

The loan limits for conforming loans are determined by the Federal Housing Finance Agency (FHFA) and are adjusted annually to reflect changes in housing prices. As of 2023, the conforming loan limit for a single-family home is $647,200 in most areas of the United States.

Conforming loans are the most common type of conventional loan and typically offer lower interest rates and more favorable terms than non-conforming loans.

Non-Conforming Loans

Non-conforming loans, also known as jumbo loans, are loans that exceed the loan limits set by Fannie Mae and Freddie Mac. These loans are typically used to purchase high-end homes or properties in expensive real estate markets.

Since non-conforming loans are not backed by Fannie Mae or Freddie Mac, they often have higher interest rates and stricter eligibility requirements than conforming loans. Borrowers need to have excellent credit scores and substantial down payments to qualify for a non-conforming loan.

Everything You Need to Know About Conventional Loans

Now that we’ve covered the basics of conventional loans, let’s take a closer look at some of the most important things you need to know before applying for one.

Eligibility Requirements

To qualify for a conventional loan, you typically need a credit score of at least 620 and a debt-to-income ratio of 43% or lower. However, some lenders may require higher credit scores and lower debt-to-income ratios, especially for non-conforming loans.

You’ll also need to have a down payment of at least 3% for a conforming loan and 10-20% for a non-conforming loan. Keep in mind that if you put down less than 20%, you may be required to pay for private mortgage insurance (PMI).

Application Process

To apply for a conventional loan, you’ll need to provide detailed information about your income, employment history, credit history, and any other debts you have. You’ll also need to provide documentation such as tax returns, pay stubs, and bank statements.

Once you’ve submitted your application, the lender will review your information and determine whether you meet their eligibility requirements. If you’re approved, they’ll provide you with a loan estimate that includes details about your interest rate, monthly payments, and closing costs.

Closing Costs

Closing costs are fees that borrowers are required to pay when they close on their loans. These fees can include things like appraisal fees, title insurance, and attorney fees.

Closing costs for conventional loans typically range from 2-5% of the loan amount, so it’s important to factor these costs into your budget when planning to buy a home or make a large purchase. Some lenders may allow you to roll your closing costs into your loan, but this will increase your monthly payments and the amount of interest you pay over time.

Interest Rates

Interest rates for conventional loans can vary depending on a number of factors, including your credit score, down payment, and the current state of the economy. Generally, borrowers with higher credit scores and larger down payments will qualify for lower interest rates.

It’s important to shop around and compare interest rates from different lenders before choosing a loan. Even a small difference in interest rates can have a significant impact on the total amount of interest you’ll pay over the life of your loan.

Benefits of Conventional Loans

While conventional loans may have stricter eligibility requirements than government-backed loans, they also offer some benefits that may make them a better choice for certain borrowers. Some of the benefits of conventional loans include:

a. No mortgage insurance: If you put down at least 20%, you won’t be required to pay for private mortgage insurance, which can save you hundreds of dollars per month.

b. More flexibility: Since conventional loans are funded by private lenders, they often offer more flexibility in terms of loan amounts, down payments, and eligibility requirements.

c. Lower costs: Conventional loans may offer lower interest rates and closing costs than government-backed loans, especially for borrowers with good credit scores and large down payments.

Conclusion

Conventional loans are a popular choice for borrowers who have good credit scores, low debt-to-income ratios, and sizable down payments. There are two types of conventional loans: conforming and non-conforming, each with its own eligibility requirements and loan limits.

Before applying for a conventional loan, it’s important to understand the application process, eligibility requirements, and potential costs and benefits. By doing your research and shopping around for the best loan terms, you can find a conventional loan that meets your needs and helps you achieve your financial goals.

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