If you’re considering buying a house, you’ll likely need to take out a mortgage loan to finance the purchase. As you start to explore your options, you’ll quickly discover that there are many different types of loans to choose from.
With so many choices, picking the right loan for your needs can be tough. For many borrowers, a conventional loan is the best choice.
Let’s take a look at what a conventional loan is, how it works and what you need to qualify for this type of loan.
A conventional mortgage loan is not directly insured by a government program. Most conventional loans are also “conforming” loans, which simply means that they meet the requirements for Fannie Mae or Freddie Mac. Both are government-sponsored enterprises that purchase mortgages from lenders and sell them to investors. This frees up lenders’ funds so they can get more qualified buyers into homes.
Conventional mortgages are available with several different term options with most people choosing between 15-year and 30-year terms.
Because there are several different sets of guidelines that fall under the umbrella of “conventional loans,” there’s no single set of requirements for borrowers. However, in general, conventional loans have stricter credit requirements than government-backed loans like Federal Housing Administration (FHA) loans.
As with any type of mortgage loan, you’ll need to meet certain qualification requirements if you want to buy a home with a conventional loan. Let’s take a look at what you’ll need to qualify for this type of home loan.
It’s possible for first-time home buyers to get a conventional mortgage with a down payment as low as 3%. However, the down payment requirement can vary based on your personal situation and the type of loan or property you’re getting:
A mortgage calculator can help you figure out how your down payment amount will affect your future monthly payments.
If you put down less than 20% on a conventional loan, you’ll be required to pay for private mortgage insurance (PMI). PMI protects mortgage investors in case of a loan default. The cost for PMI varies based on your loan type, your credit score and the size of your down payment.
PMI is usually paid as part of your monthly mortgage payment, but there are other ways to cover the cost as well. Some buyers pay it as an upfront fee included in their closing costs. Others pay it in the form of a slightly higher interest rate. Choosing how to pay for PMI is a matter of running the numbers to figure out which option is the cheapest for you.
The nice thing about PMI is that it won’t be part of your loan forever – that is, you won’t have to refinance to get rid of it. When you reach 20% equity in the home on your regular mortgage payment schedule, you can ask your lender to remove the PMI from your mortgage payments.
If you reach 20% equity as a result of your home increasing in value, you can contact your lender for a new appraisal so they can use the new value to recalculate your PMI requirement. Once you reach 22% equity in the home, your lender will automatically remove PMI from your loan.
A conventional lender will also have the following requirements.
In most cases, you’ll need a credit score of at least 620 to qualify for a conventional loan. When you apply, your lender will check your credit history to determine if you have qualifying credit. If you don’t, you might not get approved for the loan.
Your debt-to-income ratio (DTI) is a percentage that represents how much of your monthly income goes to pay off debts. You can calculate your DTI by adding up the minimum monthly payments on all your debts (like student loans, auto loans and credit cards) and dividing it by your gross monthly income. For most conventional loans, you can be approved up to 50% DTI, however a lower DTI increased your likelihood of approval.
For a conforming conventional loan, your loan must fall within the loan limits set by Fannie Mae and Freddie Mac. For 2023, the conforming loan limit for a single-family home is $726,200. There are exceptions, however. Alaska, Hawaii and other high-cost areas of the country have higher loan limits, ranging up to $1,089,300. To see loan limits for your area, visit the Federal Housing Finance Agency website.
Let’s take a look at how conventional loans compare to some other popular loan options.
While conventional loans are available to anyone who can meet the requirements, Department of Veterans Affairs (VA) loans are a benefit of military service and are only available to veterans, active-duty servicemembers and their surviving spouses.
The requirements for VA loans are similar to that of conventional loans. VA loans, however, come with a few excellent benefits.
First, VA loans don’t require a down payment. Second, VA loans never require you to pay mortgage insurance.
If you’re thinking about getting a VA loan instead of a conventional loan, here are a few things to consider:
Conventional loans have stricter credit requirements than FHA loans. FHA loans, which are backed by the Federal Housing Administration (FHA), offer the ability to get approved with a credit score as low as 500 with a 10% minimum down payment. Credit scores above 580 (which many lenders require as your minimum qualifying score – including Rocket Mortgage ® ) only require a minimum down payment of 3.5%. While conventional loans allow you to make a slightly smaller down payment of 3%, you must have a credit score of at least 620 to qualify.
When you’re deciding between a conventional loan versus an FHA loan, it’s important to consider the cost of mortgage insurance. If you put less than 10% down on an FHA loan, you’ll have to pay a mortgage insurance premium for the life of the loan – regardless of how much equity you have.
However, you won’t have to pay private mortgage insurance on a conventional loan forever if you make a down payment of 10% or more. In that case, the mortgage insurance premiums will be canceled after 11 years.
While conventional loans are available in all areas of the country, United States Department of Agriculture (USDA) loans* can only be used to purchase properties in qualifying rural areas. Those who qualify for a USDA loan may find that it’s a very affordable loan compared to other loan options. Although Rocket Mortgage doesn’t offer USDA loans currently, we’re providing this information to you to help you understand all of your choices for mortgages.
There’s no maximum income for a conventional loan, but USDA loans have income limits that vary based on the city and state where you’re buying the home. When evaluating your eligibility for a USDA loan, your lender will consider the incomes of everyone in the household – not just the people on the loan.
USDA loans don’t require borrowers to pay private mortgage insurance (PMI), but they do require borrowers to pay a guarantee fee, which is similar to PMI. If you pay it upfront, the fee is 1% of the total loan amount. You also have the option to pay the guarantee fee as part of your monthly payment. The guarantee fee is usually more affordable than PMI.