Conventional Mortgage: What It Is and How It Works

A conventional mortgage (or conventional loan) is a home loan issued by private lenders—banks, credit unions, and mortgage companies—that is not insured or guaranteed by the federal government. Some conventional loans, however, may meet criteria to be bought or guaranteed by government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac.

Key takeaways

• Conventional loans are issued by private lenders and may be sold or guaranteed by Fannie Mae or Freddie Mac.
• They typically require higher credit scores and larger down payments than government-backed loans (FHA, VA, USDA).
• Interest rates depend on loan terms, borrower creditworthiness, market conditions, and whether you pay discount points.
• Conforming loans are a subset of conventional loans that meet Fannie Mae/Freddie Mac size and underwriting limits.

How conventional mortgages work

• Loan types: fixed-rate (same payment through the term) or adjustable-rate (rate fixed for an initial period, then adjusts).
• Lenders evaluate credit history, income, assets, employment, debt-to-income (DTI) ratio, and down payment ability.
• Many conventional loans are pooled into mortgage-backed securities (MBS) on the secondary market, which affects liquidity and pricing.
• Borrowers can lower their interest rate by paying points (one point = 1% of loan amount typically reduces rate by ~0.25%).

Example

Buying a $500,000 home with a $100,000 (20%) down payment and a 30-year conventional mortgage at 5.50% would yield an approximate principal-and-interest payment of $2,271 per month. Exact payments vary with taxes, insurance, and loan specifics.

Conventional vs. FHA and other government-backed loans

• FHA loans: backed by the Federal Housing Administration to help lower-income or lower-credit borrowers qualify. Lower down payment and more lenient credit requirements, but include mortgage insurance premiums.
• VA and USDA loans: government-backed programs that can offer no-down-payment options for qualifying veterans or rural borrowers.
• Conventional loans generally require higher credit scores (often 620+), larger down payments to avoid private mortgage insurance (PMI), and stricter underwriting than FHA, VA, or USDA loans.

Conventional vs. conforming vs. jumbo

• Conforming loans meet Fannie Mae/Freddie Mac size limits and underwriting rules. These are conventional loans that can be purchased by the GSEs.
• Jumbo loans exceed conforming limits and typically have stricter qualification requirements (higher credit score, lower DTI, larger down payment).
• Portfolio loans are held by the lender rather than sold on the secondary market and can have customized terms.

Common types of conventional loans

• Conforming conventional loans
• Jumbo loans
• Portfolio loans
• Amortizing fixed-rate loans
• Adjustable-rate mortgages (ARMs)
• Subprime conventional loans (for borrowers with weaker credit profiles)

Documentation required

Lenders usually request:
* Completed mortgage application
* Proof of income: recent pay stubs, two years of tax returns, W-2s, and documentation for other income
* Asset statements: bank and investment account statements, reserves, and gift letters if applicable
* Employment verification
* Identification and Social Security number for credit check

Interest rates and factors that affect them

Rates on conventional mortgages are influenced by:
* Borrower profile: credit score, down payment size, assets, and DTI ratio
* Loan specifics: loan amount, term, fixed vs. adjustable rate
* Market forces: expectations for inflation, supply/demand for MBS, and central bank policy
* Discount points: pay upfront to lower the rate; beneficial if you plan to keep the loan long term

Who is likely to qualify

Good candidates:
* Credit scores typically 620 or higher (best rates for higher scores)
* DTI ideally under about 36% and generally no higher than the lender’s limits (commonly around 43%)
* Ability to make a down payment (20% avoids PMI; smaller down payments may be accepted with PMI)

Who may not qualify

Conventional loans are more difficult for:
* Borrowers with credit scores below lender minimums
* Recent bankruptcies (often within 4 years) or recent foreclosures (often within 7 years)
* High DTI ratios or insufficient down payment and reserves

Frequently asked questions

What credit score do I need for a conventional loan?
* Many lenders require a minimum around 620, but underwriting standards vary. Higher scores get better rates.

Are conventional loan rates higher than government-backed loans?
* Not always. Conventional rates can be higher or lower depending on borrower credit, down payment, and market conditions. FHA loans may have lower rates for lower-credit borrowers but include mortgage insurance costs.

Should I choose FHA or conventional?
* If you have strong credit and can make a sizeable down payment, a conventional loan often yields better long-term costs (and lower or no mortgage insurance). For lower credit or smaller down payment, FHA may be more accessible.

Bottom line

Conventional mortgages are the standard home loan offered by private lenders and are suitable for borrowers with established credit and financial resources. They offer a range of fixed- and adjustable-rate products and can be packaged into conforming or nonconforming (jumbo, portfolio) loans. Compare offers, consider closing costs and mortgage insurance, and evaluate how long you plan to stay in the home before choosing the best loan type for your situation.