What is a Conventional Loan? Here’s What Buyers Need To Know

You’ve picked out the home, and imagined every little decorating detail. You’ve worked hard to improve your credit score, pay down your debts, and save up for a healthy down payment. Finally, you’re ready to buy that dream home and tackle this whole mortgage thing once and for all.

Except suddenly, you’re met with confusing terminology: “conventional,” “conforming,” “non-conforming,” and “government-backed.” What does any of that even mean? It’s all so overwhelming that you just wish someone would come over to your home, brew you a hot cup of tea, and walk you through it all step-by-step.

That’s where we come in — though sadly, you’ll have to brew your own tea. We talked to Jessica Sanchez, Director of Underwriting & Loan Management at HomeLight Home Loans, to walk through the ins and outs of conventional loans. Here’s what you need to know.

What’s a conventional loan?

A conventional loan is a private mortgage that’s not backed by the federal government (we’ll get to government loans in a bit).

Most homebuyers get a conventional loan. In fact, according to recent data, 73% of buyers use conventional loans.

All buyers who want to use a conventional loan will have to meet certain credit, debt, and savings requirements, as defined by the specific lender.

The different types of conventional loans

There are two main types of conventional loans: conforming and non-conforming.

Conforming loans

Conforming loans are mortgages that conform to financing standards set by the federal government, and can therefore be purchased by Fannie Mae and Freddie Mac. Most buyers use conforming loans.

Who sets the requirements for conforming loans (and what are they)?

Fannie and Freddie are government-sponsored entities (GSE) that back most of the mortgages in the U.S. Here’s how it works.

Fannie and Freddie set requirements that all buyers have to meet to get a conforming loan.

These requirements include:

Minimum credit score of at least 620
Maximum debt-to-income ratio of 43% (this is known as DTI, and it looks at how much debt you pay each month versus how much income you bring in)
Minimum down payment amount of 5% (or even as low as 3% for certain programs for low- to middle-income borrowers)

If a buyer meets the minimum requirements, they should be able to qualify for a conventional, conforming mortgage.

A few caveats:

Each lender can have their own requirements on top of the Fannie and Freddie minimum requirements. For example, a lender can require a minimum credit score of 700 on a loan, as it goes above and beyond the Fannie and Freddie requirements. But that same lender can’t issue a conforming loan to a buyer with a 540 credit score, as that’s lower than the minimum Fannie and Freddie requirement.
When the economy is shaky or lending becomes riskier, lenders can tighten their requirements, and it can be harder to get a conforming loan. For example, after the coronavirus hit, many lenders tightened their requirements — raising their minimum credit scores to 700 — which locked out buyers who would have qualified just a few months earlier.
Your credit score helps determine your mortgage rate, so just because you meet the minimum requirements doesn’t mean you’ll get the best rates. The best rates are generally reserved for buyers with a score of 740 or higher.
After the buyer gets a conforming mortgage, the lender typically sells the loan back to Fannie and Freddie. This is why lenders meet the Fannie and Freddie requirements in the first place, so they can sell the loans back to the GSEs or other investors, freeing up their money to make more mortgages.