How Do Conventional Loans Compare to Other Options?
Hey there, future homeowners! Buying a home is a HUGE milestone, and getting the right mortgage is absolutely key to making that dream a reality without turning into a nightmare. Imagine this: Sarah and Tom, a young couple, are finally ready to buy their first home. They've saved diligently, and are super excited to start this next chapter. But... mortgages can be confusing, right? They're not alone if they feel a little overwhelmed.
One type of loan you've probably heard about is the conventional loan. But what exactly is it? Well, in a nutshell, a conventional loan is a mortgage that isn't backed by a government agency (we'll talk about those later!). These loans are typically offered by banks, credit unions, and mortgage companies. They're popular because they offer flexibility and, if you're a strong borrower, can come with some sweet perks.
So, what's the point of this post? Simple: we're going to break down conventional loans and see how they stack up against other common options like FHA, VA, and USDA loans. By the end, you'll have a much clearer understanding of which type might be the best fit for your unique situation.
Choosing the right mortgage is seriously important. It affects your monthly payments, how much you pay over the life of the loan, and even how quickly you can build equity in your home. Let's dive in, shall we?
1. What is a Conventional Loan?
A conventional loan is a mortgage that is not backed by a government agency like the FHA, VA, or USDA. Instead, it’s funded by private lenders, such as banks, credit unions, and mortgage companies. These loans typically follow the guidelines set by Fannie Mae and Freddie Mac, which means they must meet certain loan limits and borrower qualifications.
Definition and Characteristics
Not insured or guaranteed by the government – Unlike FHA, VA, or USDA loans, conventional loans don’t come with federal protection for lenders. This often means stricter qualification requirements for borrowers.
Higher down payment requirements – While some conventional loans allow down payments as low as 3%, many require 5% or more, especially for borrowers with lower credit scores.
Stricter credit score requirements – To qualify for a conventional loan, you typically need a credit score of 620 or higher. However, to get the best interest rates, a score of 740+ is recommended.
Loan limits vary – The Federal Housing Finance Agency (FHFA) sets loan limits for conforming conventional loans each year. If a loan exceeds these limits, it’s considered a jumbo loan, which has even stricter requirements.
Types of Conventional Loans
1. Fixed-Rate Mortgages
A fixed-rate mortgage has a stable interest rate that never changes over the life of the loan. This makes it a great option for homebuyers who want predictable monthly payments and plan to stay in their home long-term.
Best for: Buyers who value stability and plan to stay in their home for many years.
2. Adjustable-Rate Mortgages (ARMs)
An adjustable-rate mortgage (ARM) starts with a lower interest rate for a set period (e.g., 5, 7, or 10 years) and then adjusts annually based on market conditions.
While ARMs can be beneficial for short-term homeowners, they come with some risk—your interest rate could increase significantly over time.
Best for: Buyers who plan to sell or refinance before the adjustable period begins.
3. Conforming vs. Non-Conforming (Jumbo Loans)
Conforming loans – Follow Fannie Mae and Freddie Mac guidelines and stay within FHFA loan limits.
Non-conforming (Jumbo) loans – Exceed loan limits and are typically used for high-cost homes. These loans require higher credit scores and larger down payments.
Best for: Buyers purchasing expensive homes that exceed local loan limits.
Pros of Conventional Loans
No Mortgage Insurance with 20% Down – Unlike FHA loans, which require mortgage insurance for the life of the loan, conventional loans allow you to cancel PMI once you reach 20% equity.
More Flexibility – Conventional loans can be used to finance a broader range of property types, including second homes and investment properties, which FHA, VA, and USDA loans often don’t allow.
Lower Interest Rates for Strong Borrowers – If you have a high credit score (740+), stable income, and a strong financial profile, you may qualify for some of the lowest interest rates available.
Cons of Conventional Loans
Higher Down Payment Requirements – While some conventional loans allow 3% down, many require 5%–20% depending on the borrower’s credit score and loan type.
Stricter Credit and Income Requirements – A credit score of 620+ is required, and lenders prefer a debt-to-income ratio (DTI) under 43%. If your credit score is lower or your DTI is higher, you may struggle to qualify.
Private Mortgage Insurance (PMI) – If you put less than 20% down, you’ll need to pay PMI, which can add to your monthly mortgage costs until you reach 20% equity.
2. Conventional Loans vs. FHA Loans
FHA loans are mortgages insured by the Federal Housing Administration (FHA), making them a great option for homebuyers who may not qualify for a conventional loan due to lower credit scores or smaller down payments. Because they are government-backed, lenders take on less risk, allowing for more flexible approval requirements.
Key Differences
Down Payment
Conventional Loans: Down payments start at 3%–5%, but to avoid Private Mortgage Insurance (PMI), you’ll need at least 20% down.
FHA Loans: Require a minimum down payment of 3.5%, even for borrowers with lower credit scores (580+).
Bottom line: If you have limited savings, FHA loans can make homeownership more accessible. But if you can afford 20% down, a conventional loan helps you avoid mortgage insurance costs.
Credit Score Requirements
Conventional Loans: Typically require a minimum credit score of 620, but for the best rates, you’ll need 740+.
FHA Loans: Allow credit scores as low as 500, but if your score is between 500–579, you’ll need a 10% down payment.
Bottom line: FHA loans are more forgiving if you have a low credit score or limited credit history. If your score is high, a conventional loan offers better rates and lower fees.
Mortgage Insurance
Conventional Loans: Require Private Mortgage Insurance (PMI) if your down payment is less than 20%. The good news? PMI can be canceled once you reach 20% equity.
FHA Loans: Require two types of mortgage insurance:
Upfront Mortgage Insurance Premium (UFMIP): A one-time fee (1.75% of the loan amount) added to the loan.
Annual Mortgage Insurance Premium (MIP): Paid for the life of the loan unless you refinance into a conventional loan.
Bottom line: Conventional loans offer more flexibility when it comes to mortgage insurance, while FHA loans require it for the entire loan term (unless refinanced).
Loan Limits
Conventional Loans: Must follow conforming loan limits set by Fannie Mae and Freddie Mac, which vary by location.
FHA Loans: Have their own loan limits, which tend to be lower than conventional loan limits in many areas.
Bottom line: If you’re looking for a higher loan amount, a conventional loan may offer more flexibility.
Property Requirements
Conventional Loans: Can be used for a variety of property types, including investment properties, vacation homes, and multi-unit properties.
FHA Loans: Have stricter property standards—the home must meet safety, security, and livability requirements. FHA loans also cannot be used for investment properties.
Bottom line: If you’re buying a fixer-upper or investment property, a conventional loan is the better choice.
When to Choose FHA vs. Conventional
Choose an FHA Loan if:
Your credit score is below 620.
You have limited savings for a down payment.
You’re buying your first home and need a more flexible approval process.
Choose a Conventional Loan if:
You have a higher credit score (620+), ideally 740+.
You can put 20% down to avoid PMI.
You want more loan options (e.g., investment properties, vacation homes).
3. Conventional Loans vs. VA Loans
VA loans are guaranteed by the U.S. Department of Veterans Affairs (VA) and are available exclusively to eligible veterans, active-duty service members, and surviving spouses. These loans come with exceptional benefits, including zero down payment and no mortgage insurance.
Key Differences
Eligibility
Conventional Loans: Available to any qualified borrower who meets credit, income, and down payment requirements.
VA Loans: Available only to eligible military personnel and their families.
Bottom line: If you qualify for a VA loan, it’s usually a better deal than a conventional loan.
Down Payment
Conventional Loans: Typically require at least 3%–5% down.
VA Loans: No down payment required, making homeownership more accessible for veterans.
Bottom line: VA loans make it easier to buy a home without saving for a down payment.
Mortgage Insurance
Conventional Loans: Require PMI if the down payment is less than 20%.
VA Loans: No mortgage insurance required, which helps lower monthly payments. However, there is a VA funding fee (which can be rolled into the loan).
Bottom line: VA loans save you money by eliminating mortgage insurance costs.
Loan Limits
Conventional Loans: Must follow FHFA conforming loan limits.
VA Loans: Have no official loan limits for borrowers with full VA entitlement, but lenders may impose their own restrictions.
Bottom line: VA loans offer more borrowing power in some cases.
When to Choose VA vs. Conventional
Choose a VA Loan if:
You qualify for VA benefits.
You want a zero down payment option.
You want to avoid mortgage insurance costs.
Choose a Conventional Loan if:
You aren’t eligible for VA benefits.
You’re buying an investment property or second home (VA loans are only for primary residences).
You prefer to avoid the VA funding fee (especially if you’re putting down 20% or more).
4. Conventional Loans vs. USDA Loans
USDA loans are backed by the U.S. Department of Agriculture (USDA) and are designed to help low- to moderate-income buyers purchase homes in rural and suburban areas. These loans come with attractive benefits, such as zero down payment and competitive interest rates, making homeownership more accessible.
Key Differences
Location Restrictions
Conventional Loans: Can be used anywhere, including urban, suburban, and rural areas.
USDA Loans: Only available in USDA-designated rural and suburban areas.
Bottom line: If you're looking at homes in a rural or suburban area, a USDA loan could be a great choice—but if your desired home is in a city, you’ll need to explore conventional or other loan options.
Income Limits
Conventional Loans: No income restrictions—you qualify based on your credit, debt-to-income ratio, and financial history.
USDA Loans: Have income limits based on location and household size. These loans are intended for low- to moderate-income borrowers, so if your income is too high, you won’t qualify.
Bottom line: If you meet USDA income limits, this loan can be a fantastic no-down-payment option. If you exceed the limits, a conventional loan may be necessary.
Down Payment Requirements
Conventional Loans: Require 3%–5% down, or 20% to avoid PMI.
USDA Loans: No down payment required—you can finance 100% of the home’s value.
Bottom line: If you can’t afford a down payment, USDA loans offer an advantage—but they’re only available in eligible areas.
Mortgage Insurance
Conventional Loans: Require Private Mortgage Insurance (PMI) if you put down less than 20%. PMI can be canceled once you reach 20% equity.
USDA Loans: Have two types of fees:
Upfront Guarantee Fee (typically 1% of the loan amount, rolled into the loan).
Annual Fee (about 0.35% of the remaining loan balance, paid monthly).
Bottom line: While both loans require extra costs if you’re putting little or nothing down, PMI on a conventional loan can be removed later, while USDA fees remain for the life of the loan.
When to Choose USDA vs. Conventional
Choose a USDA Loan if:
You’re buying a home in a USDA-eligible rural or suburban area.
You meet income limits for your area.
You want a zero down payment loan.
Choose a Conventional Loan if:
You’re buying in an urban area or outside a USDA-eligible zone.
You don’t qualify for a USDA loan due to income limits.
You prefer a loan with fewer restrictions and the ability to remove mortgage insurance.
5. Other Loan Options
While FHA, VA, and USDA loans are the most common alternatives to conventional loans, there are other options worth considering:
Jumbo Loans: For buyers who need a loan above conventional conforming limits (typically $726,200 in most areas, higher in expensive markets).
State and Local Programs: Many states offer first-time homebuyer programs and down payment assistance. These can make buying a home more affordable.
Portfolio Loans: Offered by lenders who keep the loan in-house instead of selling it to investors. These loans can have more flexible qualification criteria.
Bottom line: If you’re in a unique financial situation or purchasing an expensive home, these alternative loans may be worth exploring!
6. Factors to Consider When Choosing a Loan
Choosing the right mortgage involves more than just comparing interest rates. Here are key factors to keep in mind:
Credit Score
Conventional loans typically require a credit score of 620+.
FHA and USDA loans allow lower scores, but with additional costs.
Tip: Check your credit report before applying and work on improving your score to get the best rates!
Down Payment
Can you afford 5% or more? A conventional loan might be best.
Do you need a zero down payment? VA and USDA loans could be a better fit.
Income & Debt-to-Income Ratio (DTI)
Lenders evaluate your DTI to ensure you can afford the loan.
FHA and USDA loans allow higher DTI ratios, making them more forgiving.
Interest Rates & Fees
Interest rates vary based on credit score, loan type, and lender.
Be sure to compare closing costs and mortgage insurance fees.
Long-Term Financial Goals
Will you live in the home long-term or plan to refinance later?
If you plan to sell in a few years, an ARM (adjustable-rate mortgage) might make sense.
Property Type & Location
Some loans, like USDA and VA, have restrictions on location or property type.
Tip: Think about how your home purchase fits into your overall financial future before choosing a loan!
7. How to Apply for a Conventional Loan
Ready to apply for a conventional loan? Here’s how to get started:
Get Pre-Approved
Pre-approval shows sellers you’re a serious buyer.
It also gives you a clear idea of what you can afford.
Gather Financial Documents
Lenders will typically ask for:
Pay stubs (proof of income).
Tax returns (usually the last two years).
Bank statements (to verify savings and assets).
Credit report (lenders will check your score).
Shop Around for Lenders
Compare interest rates, fees, and terms.
A difference of just 0.5% in interest rates can save you thousands over time!
Work with a Mortgage Professional
A mortgage broker can help compare loan options and find the best rates.
FINAL THOUGHTS
Whew! We've covered a lot of ground! Conventional loans are just one of many options available to homebuyers. They offer flexibility and the potential to eliminate PMI, but they typically require a larger down payment and stricter credit requirements. FHA loans are great for those with lower credit scores and smaller down payments, while VA loans offer amazing benefits to eligible veterans. USDA loans are a fantastic option for those looking to buy in rural areas.
Choosing the right mortgage is a big decision that can affect your financial well-being for years to come. Take your time, do your research, and don't be afraid to ask questions!
The best way to decide which loan option is right for you is to consult with a qualified mortgage professional. They can assess your individual circumstances and help you find the perfect fit!
At The Next Chapter Mortgage, our dedicated mortgage advisors are ready to guide you through the approval process with personalized support. We understand that navigating the complexities of buying a home can be overwhelming, and we're committed to making it easier for you.
We invite you to reach out to us to explore your options and see if a Conventional Loan is a good fit for you. We're excited to help you take this important step toward homeownership!
