Is a Conventional Loan a Good Choice for You?

Homeownership often requires a mortgage. Conventional loans are a widely used financing option. This article explores their characteristics and suitability, helping you determine if this loan aligns with your homeownership goals.

Understanding Conventional Loans

Conventional loans are mortgages not insured or guaranteed by government agencies like the FHA, VA, or USDA. Private lenders originate and service these loans, which are the most common type of mortgage available.

Conventional loans are either conforming or non-conforming. Conforming loans meet specific guidelines and loan limits set by the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac. For 2025, the baseline conforming loan limit for a single-unit property is $806,500, with higher limits up to $1,209,750 in high-cost areas. Non-conforming loans, or jumbo loans, exceed these limits and have stricter qualification criteria.

Conventional loan requirements include a minimum credit score, typically around 620, with higher scores yielding better rates. Lenders also evaluate debt-to-income (DTI) ratio, comparing monthly debt to gross income; while 43% is preferred, exceptions up to 50% are possible. Down payments can be as low as 3%, though 20% is recommended to avoid private mortgage insurance.

Private Mortgage Insurance (PMI) is required for conventional loans with less than a 20% down payment. PMI protects the lender if the borrower defaults. Its annual cost ranges from 0.5% to 1.5% of the original loan amount, varying by credit score and loan-to-value ratio. Unlike some government-backed insurance, PMI can be canceled once sufficient equity is built, typically at 80% or 78% loan-to-value.

Conventional loans offer fixed-rate mortgages and adjustable-rate mortgages (ARMs). Fixed-rate mortgages maintain the same interest rate and monthly payment throughout the loan term, offering predictability. ARMs have an initial fixed-rate period, after which the interest rate can fluctuate based on an index.

Key Distinctions from Other Common Mortgages

Conventional loans differ from government-backed programs like FHA, VA, and USDA loans in eligibility, mortgage insurance, and property restrictions. These distinctions influence which loan type suits a borrower’s circumstances.

FHA loans, insured by the Federal Housing Administration, make homeownership accessible for borrowers with lower credit scores or limited down payments. They require a minimum 3.5% down payment for credit scores of 580 or higher, more flexible than conventional loans. FHA loans require both an upfront Mortgage Insurance Premium (MIP) of 1.75% and an annual MIP. For loans with less than a 10% down payment, this annual MIP is typically paid for the life of the loan, unlike conventional PMI which can be canceled.

VA loans, guaranteed by the Department of Veterans Affairs, benefit eligible active-duty service members, veterans, and some surviving spouses. VA loans generally do not require a down payment or monthly mortgage insurance. Instead, they include a one-time funding fee, ranging from 0.5% to 3.3% of the loan amount, depending on service history and down payment. This funding fee can often be financed into the loan.

USDA loans, backed by the U.S. Department of Agriculture, promote homeownership in designated rural and some suburban areas. They offer 100% financing, requiring no down payment, similar to VA loans. USDA loans also have income limitations, varying by location and household size, to serve low- to moderate-income families. While lacking monthly mortgage insurance like FHA or conventional loans, USDA loans typically include an upfront guarantee fee and an annual fee.

Situations Where Conventional Loans Are Appropriate

Conventional loans suit certain borrower profiles and financial goals. Their structure and requirements offer advantages over government-backed alternatives.

Borrowers with strong financial standing are well-suited for conventional loans. Individuals with excellent credit scores, stable income, and low debt-to-income ratios often qualify for lower interest rates. A credit score of 740 or above typically unlocks the most attractive terms, reducing the overall borrowing cost. This financial strength signals reduced risk to lenders, leading to more favorable loan conditions.

A key aspect of conventional loans is avoiding private mortgage insurance (PMI) with a sufficient down payment. When a borrower contributes 20% or more of the home’s purchase price, PMI is typically not required. This eliminates a recurring monthly expense, reducing housing costs and freeing up funds. PMI can also be canceled once 20% equity is reached, providing a pathway to lower monthly payments.

Conventional loans offer greater flexibility regarding property types and occupancy. Unlike some government-backed loans targeting owner-occupied residences, conventional loans can finance investment properties and second homes. This flexibility allows buyers to pursue diverse real estate strategies or acquire vacation properties. The broader scope of eligible properties provides more options for buyers.

Conventional loans provide various refinancing options for homeowners. Borrowers can pursue rate-and-term refinances to secure a lower interest rate or change their loan term. Cash-out refinances are also available, allowing access to home equity. These options offer financial maneuverability to reduce payments, shorten loan duration, or convert equity into liquid funds. Borrowers with FHA or VA loans can also refinance into a conventional loan to eliminate mortgage insurance premiums, provided they meet eligibility and have sufficient equity.