What Is A Conventional Loan & How Does It Work?

A conventional home loan is a large sum of money lent to a borrower by a bank, credit union, or lending agency—often referred to as a conventional mortgage when the loan is used to purchase a property. The term conventional distinguishes this kind of financial product from other types of loan, like a jumbo loan, a VA loan, or an FHA loan.

The main difference is that a conventional loan is secured through a private lender, whereas other types of mortgage loans may be backed by a government agency.

Conventional loans work like this: the bank (or credit union or lending agency) purchases property on your behalf and turns the title over to you—however, you promise to pay back the lender with interest.

Interest is the percentage rate you pay the bank for the trouble of lending you money, and it’s how the bank makes money from having lent you such a large sum. Interest rates are either fixed or adjustable; in the latter case,  they typically change once per year depending on the state of the economy. The interest rate you receive on a conventional loan will also vary based on your own personal financial profile.

Interest rates and qualifications for a mortgage can vary significantly across the wide range of home loan products available to consumers, but conventional home loan terms tend to fall into a narrower set of categories. One distinction you’ll find between the two types of mortgage products is conforming vs nonconforming loans. 

Conventional mortgages are typically lent out with 15 or 30-year repayment periods; the one that’s right for you depends on your personal finances, your income, and the interest rate you can secure. 

Conforming vs Non-Conforming Loans

 In the US, there are two federally run institutions that oversee a large portion of mortgage lending: Fannie Mae and Freddie Mac. The important takeaway is that conforming loans abide by lending standards put in place by Fannie Mae and Freddie Mac. Most importantly, these limits determine the possible size of the loan; In 2023, the conforming loan limit for a single-family home is $726,200. (Limits may be higher in certain states and territories, including Hawaii, Alaska, Guam, and the US Virgin Islands.)

Nonconforming loans, sometimes called jumbo loans exceed these borrowing amounts. Nonconforming loans can vary more in their limits, rules, and conditions. Because they present a larger risk to lenders, they tend to come with higher interest rates. 

If you’re curious whether the homes you are interested in can be financed with a conforming loan, you can read more about the 2023 Federal Housing Finance Agency guidelines on FHFA.gov.

Down Payment & Credit Score

A down payment is just a large lump sum of money that you pay upfront; it’s a percentage of the total cost of the home. For example, a 20% down payment on a home worth $500,000 would be $100,000; the remainder of the price could be financed through a conventional mortgage loan.

 You may have heard that you need a 20% down payment in order to afford a home. The average house costs around $300,000, so it’s understandable if you don’t have $60,000 on hand. While that 20% number is definitely still a great option if you can comfortably afford it, you don’t need to panic if you don’t have that kind of cash laying around. At Northpointe we have several options and many different programs to fit your needs. Make sure to contact me today to discuss your personalized options.

It’s important to note that if you do make a low down payment, you may have to purchase private mortgage insurance or PMI. The cost of PMI is added to your monthly mortgage payments, usually until you’ve paid 20% or more of the balance on the loan. For this reason, it’s generally a good idea to put 20% down if you can; this way, you waive PMI fees, lowering your monthly payments. 

You need at least a 620 credit score to buy a house with a conventional loan in 2023. But, you’ll find that there are several other loan types that have much lower requirements.

As mortgage lenders, we are bound by specific rules which determine what credit scores you need to buy a house, and those rules vary by your loan type.

Conventional loans are the most common loan type. On the credit score scale, which ranges from 350-850, conventional loans require a credit score of at least 620. Other loan types allow for lower credit score minimums, and some mortgage programs have no credit score requirement whatsoever.