What You’ll Learn
The difference between a conventional loan and government-backed loan
Who should consider a conventional loan
Common conventional loan approval requirements
A conventional loan is probably what you have in mind when you think of a typical mortgage for a home purchase or refinance. They're offered by banks, credit unions, and direct lenders—such as Better Mortgage—and they're far and away the most common kind of mortgage you're likely to encounter.
In fact, census data shows that conventional loans make up around 70% of all mortgaged homes in the United States. The remaining 30% are government-backed loans, offered by 3 federal government agencies: the Federal Housing Administration (FHA), the U.S. Department of Agriculture (USDA), and the Department of Veterans Affairs (VA).
You may wonder what makes conventional loans so popular when compared to other loans. Let’s take a look at what conventional loans are all about—including qualifying guidelines and how to determine if a conventional loan is the best loan choice for you.
What is a conventional loan?
A conventional loan is a type of mortgage that does not come with federal government backing—meaning the government does not provide the lender with financial protections in the event that a borrower defaults on their loan. That means conventional loans are an inherently riskier lender investment than their government-backed counterparts. And that means they tend to come with more stringent requirements if you want to get approved.
Although conventional loans are not backed by the government, they operate on a set of guidelines prescribed by two government-sponsored entities: the Federal National Mortgage Association (more commonly known as “Fannie Mae”) and the Federal Home Loan Mortgage Corporation (also known as “Freddie Mac”). Both Fannie Mae and Freddie Mac purchase loans from lenders to keep the mortgage market stable and help make loans easier for consumers to obtain. So, it makes sense that they’re the ones that set the guidelines for all lenders to follow when deciding whether or not to approve a loan.
Behind the scenes, lenders sell mortgages that they’ve created (or, in mortgage speak, “originated”) so they can continue to create more. Because hundreds and thousands of mortgages are often repackaged as investment vehicles for banks and big financial institutions, the lending guidelines set up by Fannie Mae and Freddie Mac help identify a loan’s general risk level to reduce its volatility as an investment.
Types of conventional loans
So, we’ve covered the differences between conventional loans and government-backed loans. Now, let’s talk about the two kinds of mortgages within the conventional loans category: conforming loans and nonconforming loans.
As part of their conventional loans guidelines, Fannie Mae and Freddie Mac (via the Federal Housing Finance Agency) set a maximum loan limit for homebuyers and refinancers. In 2021, this figure is $548,250 in most US counties—although it is significantly higher in more expensive housing markets. (For example, the conventional loan limit in Hawai’i sits at $822,375 in 2021.) All conventional loans that fall within the Fannie Mae and Freddie Mac limits are known as conforming loans.
But what if you need to borrow more than the conforming loan limit? Well, then you’d need a non-conforming conventional loan—aka a Jumbo loan. Unfortunately, Fannie Mae and Freddie Mac do not buy Jumbo loans, so they tend to be more difficult for lenders to sell in the secondary market. These circumstances may force lenders to hold onto their Jumbo loans for a longer period, rather than recoup their costs by selling them right away. Consequently, Jumbo loans usually have higher interest rates and higher down payment requirements. In most cases, only borrowers with high incomes and high net worths qualify for these mortgages.
What do lenders review on conventional loan applications?
Now that you know a bit more about what conventional loans are, let’s take a deeper look into what it will take to get your conventional loan application approved.
Conventional loan down payment requirements
It used to be that you were essentially required to have a down payment of 20% to be approved for a conventional loan. These days, lenders are a lot more flexible, and some allow for a down payment of as little as 5% of the home's purchase price. Better Mortgage is one of those lenders, and we can help you learn more about your options if you’re interested in pursuing this route.
Keep in mind: Because there is more of a risk to the lender when you pay less up front, you will have to pay a fee on top of your monthly mortgage payment. This is what’s known as private mortgage insurance (PMI)—and it’s typically required if your loan-to-value (LTV) ratio exceeds 80%. The additional insurance premium helps lower the lender’s financial risk in return for making homeownership more attainable for borrowers who don’t have the cash for a traditional 20% down payment—or in the case of a refinance, less than 20% equity.
Conventional loan credit score requirements
In most cases, conventional loans require a credit score of 620 or higher. Lenders also look for excessive debt or certain negative events on your credit report, such as a bankruptcy or missed payments—which may make it harder for you to qualify for a conventional loan.
Conventional loan employment requirements
As part of the conventional loan application process, lenders usually ask for at least 2 years of your employment history. To make sure you can afford your mortgage, they want to confirm that your income has either stayed stable or increased. If you have unexplainable gaps or lapses in employment, your lender may ask for additional information to mitigate any risks for defaulting on your loan and to verify that you will be able to make your monthly mortgage payments.
Conventional loan asset requirements
Conventional loan lenders will also review your assets, i.e. the amounts you have in your checking, savings, and retirement accounts. When you’re buying a home, lenders look for these assets to prove that you have sufficient funds to close on the home. But they also want to be sure you’re not completely liquidating your funds as a new homeowner. Lenders need to know you have enough savings in reserves to cover your mortgage payments temporarily in the event of a sudden, unforeseen loss of income. How much you’ll need can depend on your property type—whether it’s your primary residence, second home, or an investment property.
Normally, you’ll be asked to share your asset details by providing your most recent statements of any accounts where you hold money. With few exceptions, the funds used to purchase a home or used as verified assets in a refinance must be “seasoned,” meaning they must have been in your account for at least 60 days. This rule helps to show whether funds used by borrowers were not suddenly borrowed or received just to secure the mortgage. Seasoning requirements also aim to cut down on questionable or even fraudulent large deposits.
If funds are borrowed to meet closing requirements, then the amount borrowed for the loan must be disclosed and the resulting debt-to-income ratio must be within required limits. Conversely, if funds are received without the expectation that they need to be paid back, then the source of the funds must be disclosed. For example, if you received gift funds from a parent or relative, then a gift letter from the donor and verification of the gift funds transfer is required. Other circumstances where you experienced a windfall of cash would also have to be verified—for instance, if you won lottery money or withdrew or transferred cash from savings or trust accounts to close.
Cash on hand, sometimes called “mattress money,” may not be acceptable as a form of assets because there is no way to verify how or when it was obtained.
Conventional loan property requirements
You can obtain a conventional loan for a purchase or refinance of almost any property type, whether it’s new construction, an investment property, or even a distressed property, like foreclosure or short sale.
For conventional loans, properties generally have to meet certain qualifying guidelines during an appraisal.
What if I don’t think I’ll qualify for a conventional mortgage?
If the qualifying guidelines for a conventional loan seem out of reach, there are grants available for low-income and first-time homebuyers, which can help you cover your down payment or closing costs. Another option is to consider adding a co-borrower to your loan application.
Reasons to choose Better Mortgage
If you think you might be a good candidate for a conventional loan, Better Mortgage can help you achieve your dream of becoming a homeowner. We work closely with Fannie Mae and Freddie Mac, the government-sponsored enterprises that buy the majority of mortgages in the United States. This relationship helps ensure that we can offer some of the lowest rates around. We also offer a fully online mortgage experience that can help expedite your mortgage timeline, meaning that you can be in your new home sooner than you’d think.
Ready to take the next step?