Key highlights from this article:
- A conventional mortgage loan is one that is not insured or guaranteed by the government.
- The requirements for conventional loans can vary from one lender to the next.
- Common requirements include a credit score of 600 or higher, a down payment of 3% or more, and a debt-to-income ratio no higher than 50%.
- But those guidelines aren’t set in stone. Exceptions can be made for some borrowers.
Conventional Loans: The Most Popular Mortgage Option
According to recent industry reports, conventional home loans account for around 66% of all home purchase loans. Federal Housing Administration (FHA) home loans took 20% of the market, while VA-guaranteed loans accounted for 10%. (The remaining 4% was made up of other mortgage types.)
That goes to show that conventional mortgage loans are by far the most popular financing option among home buyers today.
But what is a conventional loan exactly, and what are the requirements for this type of mortgage product? Let’s start with a definition and move on from there.
Definition: A conventional mortgage is one that is not insured by the federal government. This sets it apart from the FHA, USDA and VA loan programs, which are backed by the government.
To clarify: Conventional loans sometimes do receive mortgage insurance. This insurance is typically required whenever the loan-to-value (LTV) ratio exceeds 80%. But the insurance applied to conventional loans is provided by insurers within the private sector. It is not government insurance. FHA loans, on the other hand, receive government insurance through the Federal Housing Administration.
Minimum Requirements for Conventional Loans
The minimum requirements for a conventional or “regular” mortgage loan can vary. But most lenders today use similar guidelines when establishing their requirements for borrowers.
Borrowers typically need a down payment of 3% or more, a decent credit score, and a manageable level of debt. Those are the three most commonly used requirements for conventional loans. So let’s take a closer look at each one.
A Down Payment of 3% or More (Usually)
In 2019, most conventional mortgage loans require a down payment of 3% or more. That’s 3% of the purchase price or the appraised value.
Depending on the situation, lenders might require a larger down payment for a conventional loan. This is often true when the amount being borrowed is higher than the conforming loan limit for the county where the home is located. Lenders sometimes require larger down payments for bigger loans, simply because there is a higher level of risk.
But for a typical conventional loan in 2019, the minimum down payment requirement is usually 3% or more.
There are some specialty programs out there that allow borrowers to put down less money – and in some cases no money at all. For instance, some credit unions and other financial institutions offer zero-down mortgage loans to borrowers. But those types of programs are the exception, not the rule
The bottom line here is that most conventional loans today require a down payment of 3% or more.
It’s also important for borrowers to realize that the down payment can come in the form of a gift from a third-party donor. This is allowed under most mortgage programs, including both FHA and conventional. This is a scenario where an approved donor contributes money toward the home buyer’s down payment funds, in the form of a gift.
A Credit Score of 600 or Higher (Usually)
Different lenders have different credit-score requirements for conventional loans. But most of them set the bar somewhere around 600 on the FICO credit scoring scale.
According to a recent report from Ellie May (a software provider to the mortgage industry), very few loans went to borrowers with credit scores below 600. The majority of home loans processed through their software applications went to borrowers with credit scores of 650 or higher. Once you drop below 600, very few mortgage loans are being originated.
So while there may not be an industry-wide credit score requirement for conventional loans, there’s a pretty clear threshold at around 600. Below that level, a borrower may have a harder time qualifying for a conventional loan.
Debt-to-income (DTI) ratios are another important requirement for conventional mortgage loans. As the name suggests, this ratio compares the amount of money a person earns to the amount of money they spend on recurring monthly debts.
Mortgage lenders use DTI ratios for risk-analysis purposes. Statistically speaking, borrowers with higher debt ratios are more likely to default on their loans. That’s because they are often “stretched thin,” when compared to a borrower with a lower overall debt level.
As with credit scores, there is no industry-wide debt-to-income requirement or limit for conventional mortgage loans. It can vary from one lender to the next. With that being said, most lenders today set the bar somewhere around 45% to 50%.
This means borrowers with a debt-to-income ratio higher than 50% often have a harder time qualifying for financing.
Home Appraisals: Another Common Requirement
Home appraisals are another common requirement for borrowers seeking a conventional loan. The purpose of the appraisal is to determine the current market value (and potential resale value) of the home being purchased.
In short, the mortgage lender wants to know that the home being purchased is worth the amount the buyer has agreed to pay for it. Remember, the lender is usually the majority “stakeholder” in a typical financing scenario. So they want to know the value of the asset they are investing in.
- If the home appraiser determines that the property is worth the amount the borrower has agreed to pay (or more), then the loan will likely move forward.
- If the appraisal “comes in low” (meaning the appraiser determines that the house is worth less than the purchase price), the mortgage loan will probably come to a halt.
In this latter scenario, the buyer and seller might agree on a lower purchase price. Or the buyer might have to walk away from the deal. But that’s the subject of another article. For now, just know that a successful home appraisal is a common requirement for conventional mortgage loans.
A Homeowners Insurance Policy
Mortgage lenders almost always require borrowers to have a home insurance policy in place, before closing. This is true for most types of mortgage loans, FHA and conventional alike.
Mortgage lenders tend to invest a large amount of money into homes, at least on the front end of the transaction. So they want to make sure their investments are protected. This makes home insurance another key requirement for conventional mortgage loans.
In a typical scenario, the borrower might bring the policy binder (or some other evidence of coverage) to the closing. Or the lender might verify the homeowners policy prior to closing. It varies.
Enough Money to Cover Your Closing Costs
The closing costs associated with a home purchase can easily add up to thousands of dollars. As a borrower, you’ll need to have sufficient funds to cover these costs.
It’s common practice for mortgage lenders to review a borrower’s bank accounts, to ensure they have the funds needed to cover their closing costs and other expenses. This is a common requirement for both conventional and government-insured mortgage loans.
This is one of the reasons why lenders usually request at least two months worth of bank statements. They want to know how much money the borrower has in the bank, to ensure that they can cover all of their mortgage-related costs.
Summary and Conclusion
These are some of the standard requirements for conventional mortgage loans in 2019. As mentioned earlier, the guidelines for a particular financing program can vary from one lender to the next. Additionally, there are exceptions to many of the “rules” mentioned above.
For example, some lenders might allow a higher debt ratio if the borrower has other compensating factors that make up for it.
So you shouldn’t take any of this information as “gospel.” These are just some of the commonly used industry requirements for conventional loans.
Disclaimer: Every mortgage lending scenario is different, because every borrower is different. As a result, portions of this article may not apply to your particular situation. We encourage borrowers to speak with multiple mortgage lenders to get a better sense of their financing capacity.