What is a Conventional Loan, and How Does it Work?
Summary
A conventional loan is a mortgage loan offered by private lenders. Learn how it works, what requirements are needed and other factors to consider.
In this article:
If you’re ready to buy a home, you might be exploring different types of mortgages and trying to better understand your options. After all, the type of loan you get could impact your budget and overall finances for years to come.
A conventional loan is one option you might consider. To help you determine whether a conventional loan makes sense for your personal financial situation and needs, let’s review what the loan is, how it works and other things to keep in mind.
What is a conventional loan?
A conventional loan is a loan that is not funded by the government. Most commonly, a conventional loan is a type of mortgage that is, instead, funded by traditional, non-government lenders like banks, credit unions and mortgage companies. Although conventional loans usually come with stricter credit score and income requirements than government-backed loans, conventional loans are also more flexible than other loan options — you could take out a larger loan or finance a property that’s not your primary residence, like a home you plan to rent to someone else or a vacation home.1
People may also use the term “conventional loans” to refer to student loans, personal loans or business loans that are funded by traditional lenders.
How does a conventional loan work?
You could apply for a conventional loan with a lender like a bank, credit union or mortgage company. While each lender has their own qualification criteria, most of them look for the following when calculating your overall loan amount and the terms of your loan. OneMain Financial does not offer mortgage loans.
- Credit score: In most cases, you’ll need a minimum credit score of 620 to get approved for conventional loans. Some lenders might require higher credit scores.2
- Proof of income and employment: You’ll most likely need to show proof of income through pay stubs, W-2 forms or tax returns to demonstrate that you have adequate income to repay the loan.
- Debt-to-income (DTI) ratio: Your DTI ratio is the percentage of your income that goes toward your debts each month. Generally, if you have a lower DTI, you may qualify for more favorable loan terms. You typically need a DTI below 43% to qualify for a conventional loan.3
- Down payment: A down payment is an amount of money you pay upfront for a large purchase, usually shown as a percentage of the purchase price. In 2024, the median down payment percentage for all home buyers was 18%,4 but you may be able to find a conventional mortgage that requires a down payment as low as 3%. Note that these loans may have additional requirements, so check to make sure you qualify. You may need to be a first-time home buyer, take a homeowner education course or have a specific credit score.5 And if you put down less than 20%, you’ll have to pay private mortgage insurance (PMI), a type of insurance that lenders typically require when you make a lower down payment.
- Appraisal: Most lenders will ask you to get an appraisal of the home you’d like to buy. An appraisal can help them determine the property’s fair market value, so they don't lend you more than the home is worth.
If you get approved for a conventional loan, you agree to pay it back over a set term, which could be 15, 20 or 30 years. Also, you may choose from a fixed interest rate, which will remain the same over the life of your mortgage, or an adjustable-rate loan, which could go up and down based on market conditions.6
Types of conventional loans
Conventional loans can be conforming or non-conforming. Conforming loans follow guidelines set by government-sponsored enterprises (GSEs) to meet specific criteria related to size, credit score and down payment. Non-conforming loans don’t meet these criteria and often have different requirements and terms. Here’s a closer look at how these two types of loans differ.7
Conforming loans
Conforming loans follow the GSE guidelines set by Fannie Mae and Freddie Mac, two large companies that own most of the mortgages in the U.S. These mortgages meet the loan limits of the Federal Housing Finance Agency (FHFA), limits that usually change every year. Therefore, if you’re searching for a more expensive home or a property in a high-cost area, a conforming loan might not be an option, as the purchase price might exceed the limits. However, a conforming loan might make sense if you prefer lower interest rates and a more streamlined underwriting and closing process.
Non-conforming loans
Non-conforming loans don’t meet GSE guidelines. Typically, these loans exceed the maximum amount set by the FHFA. Non-conforming loans are typically used for expensive properties, or those that exceed typical conforming loan limits (around $806,500 for single-family homes in most areas of the country8). They’re worth considering if you’re looking for a larger mortgage or more mortgage options because you’re self-employed, an entrepreneur or have a situation that can make it more difficult for you to qualify for a conforming loan.
Pros and cons of conventional loans
Like all types of mortgages, conventional loans come with benefits and drawbacks that are important to consider, including:9
Pros
- Lower down payment requirement: You might be able to take out a conforming conventional loan with as little as 3% down. In many cases, you can use your personal savings, gift money, grants or other sources of money to cover your down payment.
- Property flexibility: You don’t have to buy a primary residence with a conventional loan. You may put it toward a vacation or rental property or a second home.
- Higher loan limits: Compared to government-backed loans, like FHA loans and VA loans, a conventional loan offers a higher loan limit, potentially allowing you to buy a more expensive property.
Cons
- Higher credit score requirements: You usually need a credit score of at least 620 to be eligible for a conventional mortgage.10 Government-backed loans are available to borrowers with less-than-perfect credit.
- Potentially higher interest rates: Factors like your credit score, credit history and income will help determine your interest rate on a conventional loan. Depending on your situation, your rate may be higher than if you were to go with a government-backed mortgage.
- Private mortgage insurance (PMI): If you put down a deposit of less than 20%, you’ll need PMI. Typically, you can roll this additional cost into your monthly loan payment.
Take your next step toward homeownership
By becoming familiar with the different mortgages available, including conventional loans, you could zero in on the right option for your situation and financial goals. Doing your homework might help you find the loan that works best for you.
Sources
1,7,10 https://www.bankrate.com/mortgages/what-is-a-conventional-loan/
2,3,9 https://www.experian.com/blogs/ask-experian/what-is-a-conventional-loan/
4 https://www.nerdwallet.com/article/mortgages/average-down-payment-on-a-house
5 https://www.bankrate.com/mortgages/3-percent-down-mortgage-guide/
7 https://www.investopedia.com/terms/c/conformingloan.asp
8 https://www.bankrate.com/mortgages/non-conforming-loans-guide/
This article is for general education and informational purposes, without any express or implied warranty of any kind, including warranties of accuracy, completeness, or fitness for any purpose and is not intended to be and does not constitute financial, legal, tax, or any other advice. Parties (other than sponsored partners of OneMain Financial (OMF)) referenced in the article are not sponsors of, do not endorse, and are not otherwise affiliated with OMF.
