What Is a Conventional Loan?

Written by: Skylar Riddle, CFP® | Financial Advisor

If you’re searching for a mortgage or want to refinance, you may have come across the term “conventional loan.” What does that mean?

The conventional loan is the most common type of loan. These are loans provided by private financial lenders and they do not receive backing from the government. In contrast, a government-backed or FHA loan receives support from the Federal Housing Administration, an agency that helps qualifying applicants secure loans. Such loans are only made by FHA-approved lenders and enjoy protection from default by mortgage insurance.

How Do Conventional Loans Work?

Various private lenders, including credit unions and banks, provide conventional loans. Lending institutions may also offer FHA loans. Conventional loans:

• May run from 15 to 30 years, with 30 years being the most common.
• May require you to pay private mortgage insurance if you don’t make a down payment of at least 20%.
• May require a credit score of anywhere from 620 to 660 or above.

Interest may vary based on your credit score: the higher your score, the lower your interest rate on a conventional loan.

How Is a Conventional Loan Different From a Government-Backed Loan?

Government backing typically allows for greater flexibility in lending terms. You can often qualify for an FHA loan with a lower credit score than you would need for a conventional loan. The security provided by government backing makes it easier for financial institutions to take risks. Someone with a credit score as low as 500 may qualify for a government-backed loan.

You can also qualify for a government-backed loan differently than a conventional loan. For example, the U.S. Department of Veterans Affairs lends to people serving in the military and their spouses or beneficiaries. You don’t need to make a down payment on a VA loan, and you won’t pay mortgage insurance, either.

Often, the same lenders who administer government-backed loans also offer conventional loans. Conventional loans can be riskier than government-backed loans. The right loan can depend on your circumstances:

• People with high credit scores and the means to make a 20% down payment may receive better interest rates and lower fees from a conventional loan.
• People with low credit scores, without the means to make a 20% down payment and who meet the stringent eligibility requirements may be better off with a government loan.

Government-backed loans charge a mortgage insurance premium, including an upfront fee calculated based on the loan amount and other charges rolled into your monthly fee. While government-backed loans appeal to those with low credit, these costs are one reason people may prefer to seek a conventional loan. Government loans also limit the amount loaned in different counties, usually setting the amount less than you can secure with a conventional loan.

What Are the Types of Conventional Loans?

The most common kinds of conventional loans are conforming and non-conforming loans. Conforming loans meet the Freddie Mac and Fannie Mae standards and don’t exceed maximum loan amounts, which can vary according to your geographic location. Other types of loans include:

• Jumbo: Allow you to borrow more than the maximum lending limit. Jumbo loans usually require a more significant down payment, higher credit score, and lower debt-to-income ratio than a conforming loan.
• Portfolio: Originate from a lender and are retained instead of put on the secondary mortgage market, a common practice. Portfolio loans often have higher interest rates.
• Subprime: Subprime loans charge higher interest rates and closing costs for people with lower credit rates and a debt-to-income ratio under 50%.
• Amortized: Set regular monthly payments through the amortized loan’s end and don’t include balloon payments.
• Adjustable: Adjustable loans begin with a fixed interest rate and then adjust based on rates in the market.

What Are the Advantages of a Conventional Loan?

Conventional loans generally have lower interest rates and higher lending limits. Many borrowers appreciate the greater flexibility of conventional loans, including the term lengths. Conforming loans meet Freddie Mac and Fannie Mae standards, making shopping for a loan easier and less stressful.

Choosing these loans means you can benefit from down payments as low as 3%. Or, if you put down a larger payment outright, you’ll pay less overall.

Obtaining a conventional loan is also appealing because as your credit score increases, your private mortgage insurance (PMI) and mortgage rate decrease. Government-backed loans tend to cost the same regardless of your Fair Isaac Corporation (FICO) score.

Another advantage of a conventional loan is that it only requires you to pay for mortgage insurance until you reach an 80% loan-to-value (LTV) ratio, or 20% equity, at which point you can cancel it. FHA and other loans require you to continue paying for insurance for a certain period or until you repay the loan. Over time, conventional loans are often a better value if they work for your financial position.

What Are the Disadvantages of a Conventional Loan?

People with lower credit scores have more difficulty obtaining a conventional loan. Non-government loans also demand higher down payments, and you must have 20% to avoid mortgage insurance. Conventional loans also have stricter qualifications because they incur more risk for financial institutions than government-backed loans.

An example of a firmer requirement is that you need a maximum debt-to-income (DTI) ratio of 45% to apply for a conventional loan. Also, you must reestablish your credit and pass various mandatory waiting periods if you’ve experienced past bankruptcy.

How to Qualify for a Conventional Loan

If you’re interested in pursuing a conventional loan, you should:

• Raise your credit score: Work on raising your credit score, especially if it is below 620.
• Seek loan preapproval: Getting preapproval for a loan lets you know how much you can qualify for.
• Reduce your debt: Reducing your debt-to-income ratio to 36% or lower will improve your chances of qualifying for a conventional loan.
• Save for your down payment: A down payment can reduce your monthly payment and remove the requirement for mortgage insurance if you put down at least 20%.

Conventional Loan FAQs

When deciding whether to apply for a conventional loan, you may have some critical questions. Here, we answer some of the top inquiries our team members receive about these loans and the process of acquiring them:

Do You Have to Put 20% Down on a Conventional Loan?

While putting 20% down on a conventional loan will help you have lower costs overall, you are not required to pay this much. You can put down a payment as low as 3%. Keep in mind that if you put down less than 20%, you will be required to pay for private mortgage insurance until you reach that amount in home equity.

Is It Better to Have a Conventional Loan or FHA Loan?

Whether you should apply for a conventional or FHA loan depends on your unique financial situation. Taking out a conventional loan may be more cost-efficient if you have a steady income, high credit score, and low DTI. Conversely, an FHA loan may be more suitable if your credit score is lower than 620 or your DTI exceeds 45%. There are several pros and cons for a conventional loan and FHA loan alike, so focus on picking one that works for you.

Is It Hard to Get a Conventional Loan?

The process of obtaining a conventional loan is simple, which explains why it is the most common option. Any difficulty you may experience is due to this loan’s stricter requirements.

How We Can Help

When Fort Pitt Capital Group starts managing your money, we provide advice and support for all aspects of our your financial life. We can talk our wealth management clients through loan recommendations using the lens of their exact situation. Plus, through our bank partners, like Focus Treasury & Credit Solutions, we can offer our clients mortgage and lending solutions for their home or business needs.

Do you need assistance working toward these goals? Fort Pitt Capital Group can provide the financial advising services you require. Contact us to speak with an advisor and discuss your financial future.

About the Author:

Skylar Riddle, CFP®
Financial Advisor
Fort Pitt Capital Group, LLC
680 Andersen Drive, Pittsburgh, PA 15220
(412) 921-1822 | sriddle@fortpittcapital.com