Is a Conventional Loan Right for You? Everything You Need to Know

Getting a mortgage to buy a home is one of the biggest financial decisions you’ll make in life. With so many options out there it can be tricky to determine which type of home loan is the best fit for your situation. One of the most common mortgage types is the conventional loan. But is a conventional mortgage right for you?

What is a Conventional Loan?

A conventional loan is a mortgage issued by private lenders like banks, credit unions, or mortgage companies. It is not backed by any government agency. Conventional loans have some requirements set by Fannie Mae and Freddie Mac, two government-sponsored enterprises that buy loans on the secondary mortgage market. However, they are not insured by any federal agency.

The most common types of conventional loans are

• Fixed-rate – Your interest rate and monthly payment stay the same for the entire loan term, usually 15 or 30 years.

• Adjustable-rate (ARM) – You have a fixed rate for the first 3-10 years, then it adjusts periodically based on the market.

• Jumbo – For loan amounts over $647,200 in most areas.

• Conforming – Loans under $647,200 that can be purchased by Fannie Mae or Freddie Mac.

Conventional Loan Requirements

To qualify for a conventional mortgage, you’ll need:

• Credit score – At least 620 or higher. The higher your score, the better rate you can get.

• Down payment – At least 3-5% down. 20% down avoids private mortgage insurance (PMI).

• Debt-to-income ratio – Most lenders want this below 43-45%.

• Loan size – Conforming loans are under $647,200. Jumbos exceed this amount.

Conventional lending standards tend to be stricter than government-backed FHA, VA and USDA loans. However, conventional loans offer more flexibility in some areas like down payments, property types, and debt-to-income ratios.

Pros of Conventional Loans

Some advantages of conventional mortgages include:

• Cancellable PMI – You can stop paying PMI once you build 20% equity.

• Lower Monthly Payments – Conventional loans allow lower down payments than FHA, so your monthly costs may be less.

• No Usage Restrictions – Conventional loans can be used to buy primary homes, vacation properties or investment properties.

• Flexible Options – Conventional programs offer fixed and adjustable rates, various terms, and jumbo amounts.

• Faster Approval – Conventional loans don’t require as much paperwork as government home loans.

Cons of Conventional Loans

Some potential drawbacks of conventional mortgages:

• Strict Credit Requirements – Conventional loans require good credit, typically at least 620. If your score is lower, an FHA or VA loan may be your only option.

• High Upfront Costs – You’ll need at least 3% down and will have to pay PMI if less than 20% down.

• Higher Rates Without 20% Down – Lower down payments mean higher rates and ongoing PMI costs.

• Tough Debt-to-Income Rules – Lenders normally want your DTI below 43%, which could disqualify some borrowers.

• Foreclosure Waiting Periods – You must wait 7 years after a foreclosure to qualify for another conventional loan.

When to Choose a Conventional Loan

Here are some instances when a conventional mortgage could be a good fit:

• You have a credit score of 620 or higher. Conventional loans require good credit.

• You can afford a down payment of at least 3-5%. This avoids high-cost FHA mortgage insurance.

• Your debt-to-income ratio is below 45%. Conventional lenders are strict about DTI.

• You have 20% down to avoid PMI. This results in the lowest rate.

• You are buying a second home or investment property. Government loans can only be used for primary residences.

• You need a jumbo loan above conforming limits. Only conventional loans go this high.

• You are able to pay off PMI once you reach 20% equity. Conventional PMI is cancellable.

Alternatives to Conventional Loans

If you don’t meet conventional loan requirements, here are some options:

FHA loans – Require only 3.5% down and a 580 credit score. But you pay an upfront mortgage insurance premium and higher ongoing premiums.

VA loans – Offer 100% financing with no down payment to qualifying veterans and service members. Credit score and income requirements still apply.

USDA loans – Provide 100% financing in designated rural areas to borrowers meeting income limits. Credit scores as low as 640 may qualify.

Subprime loans – Designed for borrowers with credit scores below 620. Come with higher rates and costs to offset the added risk.

Non-Qualified Mortgages – Alternative mortgages that allow more flexible underwriting for self-employed borrowers or those with unique situations.

Down Payment Assistance Programs – State and local programs provide grants, loans or subsidies to cover all or part of a down payment for eligible buyers.

The Bottom Line

Conventional loans offer reasonable down payments, flexible options and cancellable PMI to borrowers with good credit. However, government-backed mortgages like FHA and VA loans can be better for those will less-than-perfect credit or finances. Shop around and compare multiple loan types to find the best mortgage for your situation. With the right home loan choice, you can make homeownership affordable and achieve your real estate dreams!