What Are Conventional Loans?
Conventional loans are a category of mortgage financing that is not insured or guaranteed by a government agency, such as the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA).44 Instead, these loans are originated and backed by private lenders, including banks, credit unions, and other financial institutions. They form a significant part of the broader field of mortgage finance, representing the most common type of home loan in the United States.43
To qualify for conventional loans, borrowers typically need stronger financial profiles compared to those seeking government-backed alternatives. This often includes a higher credit score, a lower debt-to-income ratio (DTI), and a more substantial down payment. While conventional loans offer greater flexibility in terms and conditions, they come with stricter underwriting standards.
History and Origin
Before widespread government involvement in housing finance, mortgages were largely conventional loans, characterized by short terms, high down payments, and balloon payments, making homeownership challenging for many.42 The landscape of conventional loans was significantly shaped by the establishment of government-sponsored enterprises (GSEs) like Fannie Mae (Federal National Mortgage Association) in 1938 and Freddie Mac (Federal Home Loan Mortgage Corporation) in 1970.41 Fannie Mae was created during the Great Depression to provide liquidity to the mortgage market by purchasing FHA-insured loans.40 Freddie Mac was later established to increase competition and further enhance the liquidity of the secondary mortgage market.39
Initially, Fannie Mae focused on FHA and VA loans. However, in 1970, Congress authorized both Fannie Mae and Freddie Mac to purchase conventional loans—those not insured or guaranteed by federal agencies. This move was pivotal, as it allowed these GSEs to buy mortgages directly from lenders, package them into mortgage-backed securities (MBS), and sell them to investors. T38his mechanism provided a continuous, stable supply of funds for lenders, ensuring that money was available for new home loans. O37ver time, the standards set by Fannie Mae and Freddie Mac for the loans they purchase became the de facto standards for conforming conventional loans in the market.
Key Takeaways
- Conventional loans are not insured or guaranteed by U.S. government agencies but are backed by private lenders.
- These loans often require higher credit scores and more substantial down payments compared to government-backed options.
- "Conforming" conventional loans adhere to specific criteria set by Fannie Mae and Freddie Mac, including conforming loan limits.
- If the down payment is less than 20% of the home's purchase price, borrowers typically need to pay private mortgage insurance (PMI).
- They offer various repayment structures, including fixed-rate mortgage and adjustable-rate mortgage options.
Interpreting Conventional Loans
Conventional loans are interpreted as a benchmark for borrower creditworthiness due to their stricter qualifying criteria. Lenders assess a borrower's financial health through their credit score, employment history, and financial reserves. A high credit score signals to lenders that the borrower is a lower risk, often resulting in more favorable interest rates.
When evaluating a conventional loan offer, prospective homeowners should consider the proposed loan-to-value (LTV) ratio. A lower LTV, typically achieved with a larger down payment, can result in a lower interest rate and may eliminate the need for private mortgage insurance. The presence of PMI on a conventional loan, while common for lower down payments, adds to the monthly housing expense and is a key factor in overall affordability.
Hypothetical Example
Consider Sarah, who is looking to purchase a home for $350,000. She has a strong credit score of 740 and has saved $70,000 for a down payment. This represents a 20% down payment on the home's purchase price.
Sarah approaches a private lender for a conventional loan. Because her down payment is 20% of the home's value, her loan-to-value (LTV) ratio is 80%. This means she avoids the requirement for private mortgage insurance (PMI), which would have been necessary with a smaller down payment. The lender offers her a 30-year fixed-rate conventional loan at an interest rate of 6.5%. With a loan amount of $280,000 ($350,000 - $70,000), her estimated principal and interest payment would be approximately $1,770 per month, not including taxes and insurance. This scenario demonstrates how a strong financial position, including a sufficient down payment, can lead to more favorable terms for a conventional loan.
Practical Applications
Conventional loans are widely used for a variety of real estate transactions, from purchasing primary residences to acquiring investment properties. They are particularly prevalent when borrowers have established credit histories and significant savings for a down payment.
One of the most significant applications of conventional loans is in the purchase of homes that fall within the loan limits set by the Federal Housing Finance Agency (FHFA). These are known as "conforming" conventional loans. For example, in most of the United States, the 2025 conforming loan limit for a one-unit property is $806,500, with higher limits in designated high-cost areas, reaching up to $1,209,750. L35, 36oans exceeding these limits are categorized as jumbo loans, a type of non-conforming conventional loan.
34The criteria for conventional loans, influenced by Fannie Mae and Freddie Mac, set de facto standards for much of the mortgage market, ensuring liquidity for lenders. T33his allows banks to continuously lend to qualified borrowers, thereby supporting the broader housing market. The Federal Housing Finance Agency (FHFA) publishes the maximum baseline conforming loan limits annually, which are crucial for lenders and borrowers in understanding the scope of conventional financing. Information on these limits can be found on the FHFA website.
31, 32### Limitations and Criticisms
While conventional loans offer flexibility and often competitive interest rates for well-qualified borrowers, they do have limitations. The most notable drawback is their stricter qualification requirements compared to government-backed loans. Borrowers typically need a credit score of at least 620 to qualify for a conforming conventional loan. F30urthermore, conventional loans usually require a minimum down payment of 3% to 5%, but a down payment of less than 20% necessitates private mortgage insurance (PMI), which adds to the monthly cost. U29nlike some government-insured options, PMI on conventional loans can be canceled once a borrower achieves sufficient home equity, typically 20% to 22% LTV.
28The interest rates on conventional loans are influenced by broader economic factors, including the Federal Reserve's monetary policy. While the Federal Reserve does not directly set mortgage rates, its decisions on the federal funds rate can indirectly affect longer-term interest rates, including those for conventional mortgages. F27or example, when the Fed raises its benchmark rate to curb inflation, mortgage rates tend to increase, making borrowing more expensive. C25, 26onversely, a weakening economy might lead the Fed to lower rates, potentially making conventional loans more affordable. T24his indirect relationship means that borrowers cannot simply assume lower mortgage rates will follow direct Fed rate cuts. As explained by Kiplinger, it is important to consider personal readiness and market conditions rather than solely timing a home purchase based on Fed actions.
23### Conventional Loans vs. FHA Loans
Conventional loans and FHA loans represent two primary paths to homeownership, differing fundamentally in their government backing and qualification criteria. The core distinction is that FHA loans are insured by the Federal Housing Administration, a U.S. government agency, which mitigates risk for lenders and allows for more lenient borrower requirements. C21, 22onventional loans, by contrast, are not government-insured and are subject to private lender standards.
20| Feature | Conventional Loans | FHA Loans |
| :-------------------- | :------------------------------------------------- | :----------------------------------------------- |
| Government Backing | None (private lender-backed) | Insured by Federal Housing Administration (FHA) |
| Minimum Credit Score| Generally 620+ for conforming loans 19 | As low as 500 (with 10% down) or 580 (with 3.5% down) |17, 18
| Minimum Down Payment| As low as 3% (for conforming loans) 16 | 3.5% (for 580+ credit score) or 10% (for 500-579 credit score) |14, 15
| Mortgage Insurance | Private Mortgage Insurance (PMI) if LTV > 80%; can be canceled |13 Upfront Mortgage Insurance Premium (MIP) and annual MIP; often lasts for life of loan |12
| Loan Limits | Higher, subject to FHFA conforming limits (e.g., $806,500 in most areas for 2025) |10, 11 Lower, specific FHA limits (e.g., $472,030 in some areas) |8, 9
| Flexibility | More flexible terms and property types | Stricter property requirements, primary residence only |7
While FHA loans are designed to make homeownership more accessible, especially for borrowers with lower credit scores or smaller down payments, they typically require both an upfront and an annual mortgage insurance premium, which often cannot be canceled unless the loan is refinanced. C6onversely, conventional loans can be more cost-effective for borrowers with strong credit and sufficient down payments, as PMI can be avoided or removed. For borrowers with good credit and a moderate down payment, conventional loans often result in lower overall costs than FHA loans.
5### FAQs
What is the difference between a conforming conventional loan and a non-conforming conventional loan?
A conforming conventional loan meets the specific guidelines set by Fannie Mae and Freddie Mac, primarily regarding the loan amount. A4 non-conforming loan, such as a jumbo loan, exceeds these loan limits and may have different underwriting requirements set by the individual lender.
3Do conventional loans always require a 20% down payment?
No, conventional loans do not always require a 20% down payment. While a 20% down payment is ideal because it allows borrowers to avoid private mortgage insurance (PMI), some conventional loan programs permit down payments as low as 3% or 5%. H2owever, a down payment less than 20% typically means that PMI will be required.
Can I get a conventional loan with a lower credit score?
While conventional loans generally require higher credit scores than government-backed options like FHA loans, the minimum score can vary by lender and loan program. For conforming loans, a credit score of at least 620 is generally needed. H1owever, borrowers with lower scores might face higher interest rates or be required to make a larger down payment.
Are conventional loans only for buying a home?
No, conventional loans are not exclusively for purchasing a home. They can also be used for refinancing an existing mortgage, including a cash-out refinance, or for purchasing other types of real estate, such as investment properties or vacation homes, depending on the lender's guidelines.
How do interest rates for conventional loans compare to other loan types?
Interest rates for conventional loans are typically competitive for borrowers with strong financial profiles. They tend to be lower than FHA loan rates for borrowers with excellent credit and higher down payments, primarily because the absence of government insurance means the lender takes on more risk, which is offset by the borrower's strong qualifications. However, rates are always subject to market conditions and the borrower's individual financial situation.