Conventional Loans: Requirements and What You Need

What is a Conventional Loan?

A conventional loan, also known as a conventional mortgage, is a loan offered by private lenders such as banks, credit unions, or mortgage companies. These loans are not backed by the government. Many conventional loans are purchased by Fannie Mae and Freddie Mac, so lenders often require you to meet their standards.

Unlike FHA, VA, or USDA loans that are available to specific buyers based on factors like income, location, or military service, conventional loans are open to borrowers who meet the lender’s qualification requirements.

The Difference Between Conventional and Government Loans

Government-backed loans, like FHA, VA, and USDA loans, are insured by the federal government, which provides lenders with protection if the borrower defaults. This insurance allows lenders to offer loans to individuals who may not qualify for a conventional loan. Government loans often come with more flexible terms, such as lower down payments and interest rates, for those who meet the criteria.

On the other hand, conventional loans are not insured by the government and usually have stricter requirements, such as higher credit scores and larger down payments. These loans are more appealing to investors, which is why many lenders sell them after closing.

Conventional Loan Requirements

Conventional loans typically require a higher level of qualification than government-backed loans. Requirements can vary by lender, but here are some general guidelines:

• Minimum Credit Score: Generally, a credit score of 620-660 is required, though higher scores (720 or above) will usually get you the best rates.

• Debt-to-Income Ratio (DTI): Lenders will calculate your DTI by comparing your monthly debt obligations to your monthly income. A DTI of around 45% is typical, but some borrowers may qualify with a DTI as high as 50% or as low as 36%, depending on other factors.

• Down Payment: You can make a down payment as low as 3%, but if you put down less than 20%, you’ll need to pay for private mortgage insurance (PMI). The higher your down payment, the less you’ll pay in PMI.

What You Need for a Conventional Loan

To apply for a conventional loan, lenders will require documentation such as:

• Proof of Income: Recent pay stubs and tax returns.
• Employment Verification: Lenders will check that you're currently employed.
• Assets: Bank statements and proof of any gift funds used for your down payment.
• Proof of Identity: A valid ID, such as a driver’s license.
• Credit Report: Lenders will check your credit score and history.

Conforming vs. Non-Conforming Loans

Conventional loans can be conforming or non-conforming. A conforming loan meets the guidelines set by Fannie Mae and Freddie Mac, including a loan limit (which for 2024 is $766,550). Non-conforming loans, such as jumbo loans, do not meet these guidelines, often because the loan amount exceeds the conforming limit.

Pros and Cons of Conventional Loans

Pros:

• Flexible loan terms and options.
• Available for second homes or investment properties.
• PMI can be removed once you reach 20% equity.
• Down payments can be as low as 3% for qualified buyers.

Cons:

• Stricter qualification criteria, particularly around credit scores and debt-to-income ratios.
• Requires PMI if the down payment is less than 20%.

How to Get a Conventional Loan

You can begin the process with a pre-qualification, which gives you a general idea of what loans you may qualify for without affecting your credit score. Once you’re ready, you can apply for pre-approval, which requires a credit check and a review of your financial documents. If pre-approved, the loan process will proceed through underwriting and, ultimately, closing.

Interest Rates and Closing Costs

Your interest rate on a conventional loan depends on several factors, including your credit score, loan amount, and whether you choose a fixed or variable-rate mortgage. To lower your rate, you might consider paying mortgage points, where 1 point equals 1% of the loan amount and reduces your interest rate by 0.25%.

Closing costs typically range from 2-5% of the purchase price. Sellers can contribute to closing costs, with the amount depending on your down payment size.

When deciding which loan is best for you, consult with a lender to compare monthly payments, interest rates, and other factors.