Short Answer
A conventional loan is a mortgage that is not insured or guaranteed by the federal government. Conventional mortgages are typically offered by private lenders such as banks, credit unions, and mortgage companies, and many are eligible for purchase or securitization by Fannie Mae or Freddie Mac. Conventional loans can have fixed or adjustable interest rates and may be available with different down-payment requirements depending on the loan program and borrower’s qualifications.
What Is a Conventional Loan?
A conventional loan is a type of mortgage that is not insured or guaranteed by a federal government agency such as the Federal Housing Administration (FHA), Department of Veterans Affairs (VA), or U.S. Department of Agriculture (USDA).
Instead, conventional mortgages are generally provided by private lenders, including banks, credit unions, and mortgage companies.
Many conventional mortgages are considered “conforming” when they meet the requirements established by Fannie Mae or Freddie Mac. Other conventional mortgages are called “nonconforming” because they do not meet those requirements.
How Does a Conventional Loan Work?
With a conventional mortgage, a lender provides money to help you purchase or refinance a home.
You agree to repay the loan over a specific period, often 15 or 30 years.
Your monthly payment may include:
Principal
Interest
Property taxes
Homeowners insurance
Mortgage insurance, if applicable
The exact payment structure depends on the loan terms and your individual situation.
For example, if you purchase a $300,000 home and make a $60,000 down payment, you would need to finance the remaining $240,000, excluding closing costs and other adjustments.
Conventional Loan vs. Government-Backed Loan
The biggest difference is the source of the guarantee or insurance.
A conventional mortgage is not insured or guaranteed by a federal government agency.
Government-backed mortgages include programs such as FHA, VA, and USDA loans.
For example, an FHA loan is insured by the Federal Housing Administration, while VA loans are guaranteed by the Department of Veterans Affairs for eligible borrowers.
Because the programs have different rules, the eligibility requirements, down-payment requirements, mortgage insurance, fees, and other terms can differ.
What Is a Conforming Conventional Loan?
A conforming conventional loan meets specific requirements established by Fannie Mae or Freddie Mac.
One important requirement involves the maximum loan amount.
The conforming loan limits can change from year to year and can be higher in certain high-cost areas.
If a mortgage exceeds the applicable conforming loan limit or does not meet other agency requirements, it may be considered nonconforming.
What Is a Nonconforming Conventional Loan?
A nonconforming loan is a conventional mortgage that does not meet the requirements for purchase by Fannie Mae or Freddie Mac.
A common example is a jumbo mortgage.
Jumbo loans are designed for borrowing amounts that exceed applicable conforming loan limits.
Because jumbo loans can involve larger amounts of money, lenders may have different qualification requirements, such as stronger credit, greater income, additional reserves, or a larger down payment.
The requirements vary by lender.
How Much Down Payment Do You Need?
There is no single down-payment requirement for every conventional loan.
Some conventional mortgage programs allow qualified borrowers to make a relatively small down payment.
For example, certain conventional programs can allow down payments as low as 3% for eligible borrowers.
However, a smaller down payment can have consequences, including the potential requirement for private mortgage insurance.
The amount you need also depends on factors such as the lender, loan program, property type, credit profile, and other eligibility requirements.
What Is Private Mortgage Insurance?
Private mortgage insurance, commonly called PMI, can be required on a conventional mortgage when the borrower has a relatively small down payment.
PMI protects the lender rather than the homeowner.
This is different from homeowners insurance, which protects against covered risks to the property and belongings according to the policy.
The cost of PMI varies depending on factors such as the loan amount, down payment, credit profile, and other characteristics.
For borrowers who qualify, avoiding PMI may be possible by making a sufficiently large down payment or meeting other applicable requirements.
What Credit Score Is Needed?
There is no single credit-score requirement for every conventional mortgage.
Lenders consider multiple factors when evaluating an application, including credit history, income, debt, assets, loan-to-value ratio, and other information.
Some conventional mortgage programs are available to borrowers with credit scores that are not exceptionally high, while stronger credit can potentially help a borrower qualify for better terms.
The specific requirements depend on the lender and loan program.
Are Conventional Loans Fixed or Adjustable?
Conventional mortgages can have either fixed or adjustable interest rates.
With a fixed-rate mortgage, the interest rate generally remains the same throughout the loan term.
With an adjustable-rate mortgage, the rate can change after an initial period according to the terms of the loan.
A fixed-rate mortgage can make monthly principal-and-interest payments easier to predict, while an adjustable-rate mortgage can have a different payment structure and interest-rate risk.
Borrowers should understand how an adjustable rate can change before accepting the loan.
What Are the Advantages of a Conventional Loan?
Conventional mortgages can offer several features that may be useful to qualified borrowers.
They can be available with relatively low down payments.
They can be used for different types of properties, depending on the loan program.
They can offer fixed-rate or adjustable-rate structures.
They may allow PMI to be canceled under applicable conditions, unlike some forms of government mortgage insurance.
They are also widely offered by banks, credit unions, and mortgage lenders.
However, whether a conventional loan is appropriate depends on the borrower’s financial situation and the specific loan terms.
What Are the Disadvantages?
Conventional loans are not automatically the best choice for every homebuyer.
Borrowers may face stricter qualification requirements than some government-backed programs.
A borrower making a small down payment may have to pay PMI.
Interest rates and fees depend on the borrower’s qualifications and the lender.
A borrower with weaker credit or limited savings may find that another mortgage program offers different terms that better fit their situation.
This is why comparing multiple mortgage options can be useful.
Conventional Loan vs. FHA Loan
A conventional loan and an FHA loan are both common ways to finance a home, but they have different structures.
A conventional loan is not insured by the federal government.
An FHA loan is insured by the Federal Housing Administration.
FHA loans can have different credit and down-payment requirements and typically involve FHA mortgage insurance.
Conventional loans can also require mortgage insurance when the down payment is below certain thresholds.
The better option depends on factors such as credit, down payment, income, debt, property, and the specific offers available.
Conventional Loan vs. VA Loan
VA loans are designed for eligible veterans, active-duty service members, certain surviving spouses, and other qualifying borrowers.
A conventional loan does not have those military-service eligibility requirements.
VA loans can offer benefits such as potentially no down payment for eligible borrowers and no monthly private mortgage insurance.
However, VA loans have their own eligibility rules and fees.
A borrower who qualifies for both types should compare the actual costs and terms rather than assuming one option is automatically better.
Conventional Loan vs. USDA Loan
USDA loans are designed for eligible borrowers purchasing homes in qualifying rural areas and meeting applicable income requirements.
Conventional loans do not have the same USDA-specific geographic and income requirements.
USDA loans can offer financing with no down payment for eligible borrowers under the applicable program rules.
A borrower considering a USDA loan should check whether the property and household meet the current eligibility requirements.
Who Is a Conventional Loan Good For?
A conventional mortgage may be worth considering for borrowers who have a stable income, qualifying credit, manageable debt, and enough savings for the required down payment and closing costs.
It can also be useful for borrowers who want a mortgage that isn’t tied to a government-insured program.
However, eligibility and pricing vary from lender to lender, so comparing loan offers can be important.
What Should You Compare Before Choosing One?
Before accepting a conventional mortgage, don’t look only at the advertised interest rate.
Compare:
Interest rate
APR
Loan term
Down payment
Monthly principal and interest
PMI
Closing costs
Lender fees
Prepayment terms
Total amount paid over the life of the loan
You should also consider whether the rate is fixed or adjustable.
Two mortgages can have similar interest rates but very different overall costs because of fees, mortgage insurance, and other terms.
Simple Example
Imagine you want to purchase a $300,000 home.
You make a $30,000 down payment and borrow $270,000 through a conventional mortgage.
You then make monthly payments according to the loan agreement.
Your payment could include principal and interest, along with property taxes and homeowners insurance if those costs are included in your monthly mortgage payment.
If the loan requires PMI because of the down payment amount, that cost may also be included.
The actual monthly payment depends on the interest rate, loan term, taxes, insurance, PMI, and other factors.
Final Answer
A conventional loan is a mortgage that is not insured or guaranteed by a federal government agency. It is generally offered by private lenders such as banks, credit unions, and mortgage companies. Conventional mortgages can be fixed-rate or adjustable-rate and may be available with relatively low down payments for qualified borrowers.
Some conventional loans are “conforming,” meaning they meet requirements established by Fannie Mae or Freddie Mac, while others are “nonconforming,” such as certain jumbo loans.
Before choosing a conventional mortgage, compare the interest rate, APR, down payment, PMI, closing costs, loan term, and total repayment cost. The right mortgage depends on your financial circumstances and the specific loan terms you qualify for.