Conventional Loan: Definition, Requirements, and Benefits

A conventional loan is a type of mortgage that is not backed by a government agency, such as the Federal Housing Administration (FHA), Department of Veterans Affairs (VA), or the U.S. Department of Agriculture (USDA). Instead, it is issued by private lenders, banks, and credit unions, making it one of the most common financing options for homebuyers. Conventional loans typically require higher credit scores and larger down payments than government-backed loans but offer more flexibility in terms of loan amounts and property types.

These loans are often categorized into conforming and non-conforming loans. Conforming loans meet the loan limits set by Fannie Mae and Freddie Mac, while non-conforming loans, such as jumbo loans, exceed these limits and are used for higher-priced properties.

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How a Conventional Loan Works

Borrowers apply for a conventional loan through a private lender, which assesses their creditworthiness, income, and debt-to-income (DTI) ratio to determine loan eligibility. Unlike FHA, VA, or USDA loans, conventional loans require private mortgage insurance (PMI) if the down payment is less than 20%. However, PMI can be removed once the borrower reaches 20% equity in the home.

Lenders offer both fixed-rate and adjustable-rate conventional mortgages. Fixed-rate mortgages maintain the same interest rate throughout the loan term, ensuring predictable monthly payments. Adjustable-rate mortgages (ARMs) start with a lower introductory rate that adjusts periodically based on market conditions.

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Conventional Loan Requirements

Credit Score

Lenders typically require a credit score of at least 620 for a conventional loan, though higher scores (above 700) qualify for better interest rates.

Down Payment

Most conventional loans require a minimum down payment of 5%, though first-time homebuyers may qualify for a 3% down payment. A 20% down payment eliminates the need for PMI, reducing monthly costs.

Debt-to-Income Ratio (DTI)

Lenders prefer a DTI ratio below 43%, meaning the borrower’s total monthly debt payments should not exceed 43% of their gross income.

Loan Limits

Conforming loan limits are set annually by Fannie Mae and Freddie Mac. In 2024, the standard limit is $766,550 in most areas, though high-cost regions may have higher limits.

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Advantages of a Conventional Loan

Conventional loans offer competitive interest rates, flexible loan terms, and no upfront mortgage insurance fees, making them attractive for borrowers with strong financial profiles. They also allow financing for primary residences, second homes, and investment properties, whereas government-backed loans are more restrictive.

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Final Thoughts

A conventional loan is an excellent option for borrowers with good credit, stable income, and sufficient savings for a down payment. While it requires higher qualifications than FHA or VA loans, it provides greater flexibility, lower long-term costs, and the ability to remove PMI once equity reaches 20%. Homebuyers should carefully evaluate their financial situation and compare loan offers to determine if a conventional loan is the right choice for their home financing needs.