WHAT IS A CONVENTIONAL LOAN?
By Jessica Hudson | April 1, 2023
A conventional mortgage is one that’s not guaranteed or insured by the federal government. Most conventional mortgages are “conforming,” which simply means that they meet the requirements to be sold to Fannie Mae or Freddie Mac. Fannie Mae and Freddie Mac 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 can also be non-conforming, which means that they don’t meet Fannie Mae’s or Freddie Mac’s guidelines. One type of non-conforming conventional mortgage is a jumbo loan, which is a mortgage that exceeds conforming loan limits.
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 FHA loans. In most cases, you’ll need a credit score of at least 620 and a debt-to-income ratio of 50% or less.
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. If you’re not a first-time-home buyer or making more than 80% of the median income in your area, the down payment requirement is 5%. If the home you’re buying is not a single-family home (i.e. it has more than one unit), you may need to put down 15%. If you’re buying a second home, you’ll need to put at least 10% down.
Private Mortgage Insurance
If you put down less than 20% on a conforming loan, you’ll be required to pay for private mortgage insurance (PMI). PMI protects your lender in case you default on your loan. 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. 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 you 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.
For a conforming conventional loan, your loan must fall within the loan limits set by Fannie Mae and Freddie Mac. The loan limit changes annually. In 2023, the limit for a 1-unit home is $726,200. In high-cost areas of the country, there are higher limits, ranging up to $1,089,300 for a 1-unit home.