What Is a Conventional Loan for a House?

Nice PA homeUSDA, FHA, and VA mortgage lending programs all provide government-guaranteed mortgages.
These programs require a one-time mortgage insurance payment in addition to a monthly mortgage insurance premium (commonly known as PMI) (except the VA loan).

The federal government does not guarantee conventional loans. Conventional loans are mortgages that adhere to the Federal National Mortgage Association's (Fannie Mae) and Federal Home Loan Bank's underwriting (approval) requirements (Freddie Mac).

When your father and grandpa purchased a home, they sought traditional financing.
They went to a local bank and put down 5%, 10%, 15%, or 20% of the buying price.
Most likely, they obtained a standard mortgage.

After the bank or mortgage broker has finalized the mortgage, it is often sold to Fannie Mae or Freddie Mac. The lender must conform to Fannie Mae or Freddie Mac's underwriting standards in order to sell the mortgage to them. Conventional mortgages are often referred to as "conforming" loans since they "conform" to Fannie Mae or Freddie Mac lending guidelines.

Here are some of the traditional mortgage lending rules and features.

Minimum down payment for a conventional loan

Fannie Mae requires a 5% down payment on the most of loan products; however, Fannie Mae offers two 3% down payment programs. The following table compares mortgages with a 3% down payment:

HomeReady 97% LTV Conventional 97%
First Time Home Buyer requirements None At least one borrower must be a First Time Home Buyer
Income limits 80% of area median income in all census tracts No limits
Gift Funds Gift funds may be used for the down payment and closing-costs. There is no borrower required minimum amount for the down payment and closing-costs. Same
Flyer Frequently Asked Questions Conventional 97%

Credit score requirement

The minimum credit score is 620

Loan term (length of the mortgage)

The fully amortizing fixed-rate loan is available in terms of 10, 15, 20, 25, and 30 years.

Number of units

Conventional loans is restricted to one to four owner-occupied dwellings and one unit (single-family) for second residences. Condominiums and PUDs (planned urban development) that have been approved are eligible.

Mortgage insurance on a conventional loan

Traditional home loans need private mortgage insurance when the down payment is less than 20%.

Except for private mortgage insurers, who else provides private mortgage insurance? The cost is determined by the down payment (or equity in the case of a refinance), credit score, property location, and a few other factors. Both the FHA and the USDA need monthly mortgage insurance, although the amount is unaffected by credit score or property location. The conventional PMI fee may be substantial if you have a low credit score. 
Read more about PMI and MIP

Upfront mortgage insurance premium

Conventional loans do not need the purchase of "upfront" mortgage insurance.
The upfront cost for an FHA loan with the minimal down payment is 1.75 percent of the loan amount. For example, if the loan is $100,000, the borrower must pay (or finance) $1,750. The USDA's upfront fee is 1% of the loan amount, or $1,000 for a $100,000 loan. The Veteran loan has different upfront costs that are based on service eligibility and down payment.

Seller paid closing-costs

The home seller, Realtor®, builder, and lender may all contribute to the buyer's closing costs, according to Fannie Mae and Freddie Mac. The amount of seller aid is restricted by the proportion of down payment.
Read more about the seller paid closing-costs

Maximum loan amount for a conventional mortgage

The Federal Housing Finance Agency (FHFA) sets the maximum loan ceiling for Fannie Mae and Freddie Mac each year. For 2021, most US counties have the following borrowing limits:

  • 1-unit home - $548,250
  • 2-units (duplex) - $702,000
  • 3-units - $848,500
  • 4-units - $1,054,500

There are several exceptions for high-cost US counties.  See conventional loan limits for 2021

Jumbo loans are loans with loan amounts that exceed the lending restrictions.
With the exception of loan size, jumbo loans may be referred to as conforming provided they satisfy Fannie and Freddie's underwriting requirements (i.e. Conforming Jumbo Loan).

Because the jumbo loan exceeds the lending limit, it is unable to be sold to Fannie Mae or Freddie Mac and is therefore retained by the lender. There is a risk when large mortgages appear on a bank's balance sheet. If the borrower fails on the mortgage, the bank loses money. Due to the danger, banks demand a higher interest rate on jumbo loans.

Combo or piggyback loans

A second mortgage for the difference between the maximum lending limit and the entire loan amount is one method to avoid the jumbo mortgage interest rate and remove private mortgage insurance. For example, if the home's sales price is $600,000 and the borrower has a 10% down payment. The loan would be structured as follows to maintain the first loan amount at the maximum lending limit and avoid the higher jumbo interest rate.

Conventional loan limits are higher than FHA loan limits. Although the USDA home loan program does not have a lending limit, income limitations apply to USDA loans, which usually limit the maximum mortgage amount.
The maximum VA loan amount is equal to the conventional single-family loan limit.

Piggyback Loan
Sales Price $600,000
Down Payment 10%
Loan Amount $540,000
Less 1st mortgage $453,100
2nd mortgage $86,900

Another benefit of the combo or piggyback loan is to reduce the private mortgage insurance costs.

A piggyback second mortgage is when you get a home equity loan or home equity line of credit (HELOC) concurrently with your first mortgage.

Its purpose is to enable borrowers with modest down payments to get extra financing in order to qualify for a primary mortgage without having to pay private mortgage insurance.

Borrowers who make less than a 20% down payment on a home are often required to pay mortgage insurance.

For example, a borrower with a 10% down payment would usually finance the first 10% of the home's price with their down payment and the remaining 90% with a mortgage that needs mortgage insurance.

Lenders arrange loans differently when using a piggyback mortgage.

For instance, a borrower may buy a house with a 10% down payment, an 80% primary mortgage, and a 10% piggyback second mortgage.

In this case, the borrower is still borrowing 90% of the home's value, but the primary mortgage is just 80%. The piggyback second mortgage often has a higher interest rate that fluctuates frequently. Although these programs are marketed under a number of lender-specific brand names, the fundamental framework remains the same.

SOURCE: Consumer Financial Protection Bureau (CFPB)

See piggyback calculator: Blended interest-rate calculator: 80-15-5, 80-10-10 and 80-20 loans

Debt to income ratio

Lenders employ a formula to calculate the maximum loan payment/loan amount.
The debt-to-income ratio is calculated using a method called the debt-to-income formula.

The formula is split into two parts: the front-end ratio refers to the payment limit, while the back-end ratio refers to the monthly debt and projected mortgage payment.
The maximum borrowing amount is similar to that of government-backed mortgages.
A conventional loan's maximum debt-to-income ratio (DTI) is 45 percent.

Is a conventional mortgage right for you?

Borrowers with a 10% down payment or more should choose a conventional home loan. If the credit score is less than 680, an FHA or USDA home loan may be a better option since the monthly mortgage insurance payment will be greater than with the FHA program.  Learn more about PMI and MIP

Interest rates on conventional mortgages are often higher than on government-backed loans. The reason for this is a lack of government support and the accompanying danger. However, with a great credit score and a sizable down payment, a conventional mortgage is the preferable option.

Questions and Answers About Conventional Loans

Q. Are conventional loans bad?
A. Conventional loans are an excellent option for homebuyers who have a 20% down payment (or near to it), since there is no upfront (initial) mortgage insurance and no monthly insurance cost with a 20% down payment. Mortgage insurance is never cancelled under the FHA or USDA programs. Another advantage of traditional loans is the loan amount. The loan amount exceeds the limits of the FHA lending programs. Borrowing restrictions for the USDA and VA are identical.

Q. Can I switch from an FHA loan to a conventional loan?
A. To change from an FHA loan to a conventional loan requires a refinance from the current mortgage. All the requirements for a new (conventional) mortgage apply (i.e. income, credit, debt to income ratios, etc.)

Q. Can you buy a house as is with a conventional loan?
A. Conventional loans are a little more forgiving than the government backed mortgages (FHA, VA, and USDA), however, since the house is the collateral for the mortgage, the lender will require the house to be habitable and structurally sound.

Q. Can you get down payment assistance on a conventional loan?
A. There are numerous assistance programs for home-buyers. Most down payment and or assistance grants require the borrower(s) to meet income limits of 80% of the median area income. HUD’s Office of Policy Development and Research (PD&R) provides an easy to use look up tool for county income. The assistance programs usually have exceptions for over-limit borrowers who purchase in low to moderate areas. Contact a local HUD approved housing counseling agency for any available assistance programs.

Q. How long does a conventional loan take to close?
A. The processing time period is usually constrained by third party providers (i.e. appraisers, title, and settlement companies) and lender loan volume. Expect 45 days, however, in a brisk market, 60 to 90 days is not unusual.

Read more about conventional loans at https://www.conventionalloanplus.com/