What Is a Conventional Loan?
Conventional loans are mortgages that aren’t insured or backed by government agencies. They come from private lenders, and while most follow government rules and regulations, they aren’t offered or backed by government entities. Those that follow government rules and regulations are referred to as “conforming loans.” Conventional loans usually require private mortgage insurance (PMI) if you put down less than 20% of the sales price as a down payment. Private mortgage insurance is an additional premium added to your monthly mortgage payment. It offers protection to the lender in case you fall behind or miss mortgage payments.
Minimum Down Payment for Conventional Loans
Although 20% is often suggested for a minimum down payment, it’s not a requirement. You can put as much down as you’d like, or as little as 3%, depending on your lender and the loan. A 20% down payment avoids PMI, so your monthly payments will be lower compared to a borrower who pays PMI. Using our mortgage calculator, here’s what the difference looks like for a borrower with a good credit score and a 30-year fixed mortgage for homes at different price points—$250,000, $500,000, and $900,000. The difference in the monthly payment for the house worth $250,000 is $309 more for the buyer with PMI compared to the one who doesn’t have to pay it. This amount includes the PMI payment plus additional interest expense. That’s an extra $3,708 per year or $55,620 over 15 years if you pay this until you’re midway through your 30-year loan, that’s when your lender will remove PMI regardless of your equity. PMI is required for conventional loans that don’t have a 20% down payment, but having that much as a down payment isn’t required. Still, keep in mind that you’ll have an additional PMI expense if you choose this option.
Other Conventional Loan Requirements
Conforming conventional mortgages adhere to underwriting guidelines set by the mortgage financing giants Fannie Mae and Freddie Mac. These Government Sponsored Enterprises (GSEs) play a major role in the mortgage market. The GSEs purchased 62% of the loans originated in the first half of 2020, shaping the entire market. Because of the GSEs’ influence, 97% of loans that originated in the first half of 2020 were conforming.
Your credit score: Conventional loans have credit score requirements that vary based on lender and loan. The higher your credit score, the lower your interest rate. Getting the lowest interest rate available means you’ll pay less in interest over the total life of your mortgage. You should have at least a 620 credit score if you want to get a conventional loan. Your DTI: Your debt-to-income ratio (DTI) is another factor lenders look at. This ratio is all your monthly debts divided by your gross monthly income. Your DTI shouldn’t exceed 43%, but the lower it is, the more likely you are to get approved for the full loan amount you’re requesting. A low DTI tells lenders you can comfortably pay your mortgage in the event of an emergency. The full loan amount: Conventional conforming loans have a maximum amount you can borrow. It was $548,250 for most counties in 2021, or $822,375 for high cost-of-living areas. This increases to $647,200 in 2022, or $970,800 for high cost-of-living areas. You may want to explore other financing options if you think your home price exceeds these amounts.
Nonconforming Loan Options
Conventional loans might work for many people, but they may not be the right fit for everyone. Make sure you meet the minimum requirements before completing a conventional loan application. Talk to your realtor or mortgage broker to find out if you qualify. They may suggest other options if you don’t.
FHA: The Federal Housing Administration backs loans for borrowers with credit scores as low as 500, depending on the lender, and with down payments as low as 3.5%. USDA: The U.S. Department of Agriculture backs home loans for buyers in rural areas on low or moderate incomes. You can make as little as $0 as a down payment with a USDA loan. There’s no credit score requirement. However, the borrower must show they are able to repay debts. VA: The Department of Veterans Affairs backs VA loans, available to military personnel and their families. There’s no down payment required, and you can use it many times throughout your life if you qualify.
