While government-backed loans have special features that can make them a great option for some homebuyers, they’re not right for everyone. Conventional loans offer more flexibility, allowing for a wider range of buyers and different types of properties.
If this sounds appealing, you may find yourself wondering, "What is a conventional loan, and what are the requirements for qualifying?" We’re glad you asked! The following guide will tell you everything you need to know so you can decide whether a conventional loan is right for you.
What is a Conventional Loan?
Before diving into the eligibility requirements, it’s helpful to review a basic conventional loan definition. A conventional loan is simply a type of mortgage that isn’t backed by a governmental agency and is originated and serviced by private lenders like banks, credit unions and other financial institutions.
There are two types of conventional loans: conforming and non-conforming. Each option has its benefits, and each type has different eligibility requirements.
Conforming Conventional Loans vs Non-Conforming Federal Loans
The majority of conventional loans are conforming – meaning they meet the income and down payment requirements set forth by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The loan limits are established by the Federal Housing Finance Administration (FHFA). This allows lenders to later sell the loans to these agencies, freeing up their funds so they can offer more loans to new borrowers.
Non-conforming conventional loans do not meet government agency requirements. One common type of non-conforming loan is a jumbo loan – these are for homebuyers who need to borrow more than what is allowed under a conforming loan. Other non-conforming loans include loans for borrowers with high debt, poor credit, bankruptcy or a high loan-to-value ratio.
Because of the increased risk, non-conforming loans often come with higher interest rates, greater insurance requirements, higher closing costs and other fees.
Who is Eligible for a Conventional Loan?
In general, most borrowers with a credit score around 620 and some money saved for a down payment will qualify for a conventional mortgage loan. Since conventional loans aren't required to follow government guidelines, borrowers may also find that they're able to find a loan with flexible down payment options, term lengths and more.
However, these loans aren't protected by any government agency backing and don’t receive government funds in the case of foreclosure. Therefore, it's often a bit tougher to qualify for them. Here's a closer look at the basic guidelines for most conventional loans.
Conventional Loan Requirements
Even though conventional loans aren’t backed by the federal government, they usually follow the same government lending guidelines. As a borrower, these are the requirements you should expect when applying for a conventional home loan:
A credit score of 620 or higher
A debt-to-income ratio below 50%
At least a 3% downpayment, or 20% for no PMI
However, since requirements for conventional loans are set by independent lenders, they may vary from one lender to the next. It's not uncommon to find that some lenders have set stricter requirements than those listed below.
Conventional Loan Credit Requirements
Typically, to qualify for a conventional loan, you’ll need a credit score of at least 620. Some lenders require a credit score of at least 660.
However, if you want to make a lower down payment and get the best interest rates, it's best to have a score of 740 or higher. You’ll typically be offered a lower interest rate if you have a strong credit score and credit history. This can save you thousands of dollars over the lifetime of your loan.
Borrowers applying for a jumbo loan will need a higher credit score - typically at least 700. Some lenders require a minimum credit score of 720 for jumbo loans.
Conventional Loan Debt-to-Income Requirements
Your debt-to-income ratio (DTI) represents your total monthly debts (like your car payment and your rent) divided by your pre-tax monthly income. To qualify for most conventional loans, you’ll need a DTI below 50%.
Your lender may accept a DTI as high as 65% if you're making a large down payment, you have a high credit score or have a large cash reserve. For a jumbo loan, you'll typically need a DTI of 45% or lower, and most lenders consider this a hard cap.
Conventional Loan Down Payment Requirements
The minimum down payment requirement for a conventional loan is 3% of the loan amount. However, lenders may require borrowers with high DTI ratios or low credit scores to make a larger down payment.
Even if it's not required, if you're able to make a higher down payment, you may want to consider doing so. This can often help you get a lower interest rate.
It’s also important to note that if you put down less than 20%, you will pay for private mortgage insurance (PMI) until you have at least 20% equity in your home. PMI will typically cost you an additional 0.3% to 1.5% of the loan amount each year.
If you’re taking out a jumbo loan, your lender may require you to make a larger down payment. This can range from 10% to 20% or higher depending on your lender, the amount you're requesting and the type of building you're purchasing.
Conventional Loan Limits
In 2022 the conventional loan limit is $647,200, which is a sizable bump from 2021
However, this limit is higher if you live in a high-cost area. Depending on your county, you may be able to borrow as much as $822,375 and still qualify for a conforming conventional loan.
Conventional Jumbo Loans
With today’s home prices, you may find that you need to borrow more than the amount allowed under a conforming conventional loan. In this case, you may need to take out a jumbo loan. Conventional jumbo loans often have limits of $2 million or higher.
Borrowers taking out a jumbo loan will go through the same underwriting process as those applying for a conforming conventional loan. However, borrowers will have to meet stricter qualifications since the lender takes on a greater risk by providing a larger amount of money.
Explore Conventional Loans Today
Now that you know the answer to the question, “What is a conventional loan, and who qualifies?” you’re in a better position to decide which type of home loan is best for you.
If you decide to take out a conventional loan, remember that loan requirements, interest rates and other terms can vary from lender to lender. This makes it important to shop around and make sure you’re getting the best deal before taking out your loan.
If you would like some assistance with comparing lenders, the experts at Paddio are here to help.