A conventional mortgage or conventional loan is a home buyer’s loan that is not offered or secured by a government entity. It is available through or guaranteed by a private lender or the two government-sponsored enterprises – Fannie Mae and Freddie Mac.
A conventional mortgage loan is a “conforming” loan, which simply means that it meets the requirements for 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.
One type of common non-conforming 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.
Conventional Loan Requirements
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 no more than 80% of the median income in your area, the down payment requirement is 5%.
- If the house 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.
- If you’re getting an adjustable-rate mortgage, the minimum down payment requirement is 5%.
If you’re refinancing a conventional loan, you’ll need more than 3% equity. In all cases, you’ll need at least 5% equity. If you’re doing a cash-out refinance, you’ll need to leave at least 20% equity in the home.
A mortgage calculator can help you figure out how your down payment amount will affect your future monthly payments.
If you put down less than 20% on a conventional loan, you’ll be required to pay for private mortgage insurance (PMI). PMI protects your mortgage investors 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, but there are other ways to cover the cost as well. Some buyers pay it as an upfront fee included in their closing costs. Others pay it in the form of a slightly higher interest rate. Choosing how to pay for PMI is a matter of running the numbers to figure out which option is the cheapest for you.
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 your 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.
- Credit score: In most cases, you’ll need a credit score of at least 620 to qualify for a conventional loan. When you apply, your lender will check your credit history to determine if you have good credit. If you don’t, you might not get approved for the loan.
- Debt-to-income ratio: Your debt-to-income ratio (DTI) is a percentage that represents how much of your monthly income goes to pay off debts. You can calculate your DTI by adding up the minimum monthly payments on all your debts (like student loans, auto loans and credit cards) and dividing it by your gross monthly income. For most conventional loans, your DTI must be 50% or lower.
- Loan size: 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. For 2022, the conforming loan limit for a single-family home is $647,200. There are exceptions, however. Alaska, Hawaii and other high-cost areas of the country have higher loan limits, ranging up to $970,800. To see loan limits for your area, visit the Federal Housing Finance Agency website.