When you start looking for a home loan, you'll hear the term "conventional loan" a lot. Simply put, it's any mortgage that isn't insured or guaranteed by a federal government agency, like the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA).

Instead, these loans are offered by private lenders such as banks, credit unions, and mortgage companies. Because the government doesn't shoulder the risk, the lender sets its own terms. This distinction is the starting point for understanding how these loans work. All conventional loans fall into one of two categories: conforming or non-conforming.

The main difference between these two types comes down to a set of rules established by two government-sponsored enterprises: Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation). These organizations buy mortgages from lenders, which frees up money for the lenders to make more loans.

A conforming loan meets, or "conforms to," the guidelines set by Fannie Mae and Freddie Mac. The most well-known guideline is the loan limit, which is the maximum amount you can borrow. This limit is set annually by the Federal Housing Finance Agency (FHFA) and varies depending on the housing market in your county. In most of the U.S., the 2024 limit for a single-family home is $766,550, but it can be as high as $1,149,825 in high-cost areas.

A non-conforming loan does not meet these guidelines. The most common type is a jumbo loan, which is a mortgage that exceeds the local conforming loan limit. Lenders can't sell these loans to Fannie Mae or Freddie Mac, so they often come with slightly different interest rates and stricter requirements.

Choosing a conventional loan comes with its own set of pros and cons, largely depending on your financial situation.

Another major benefit relates to mortgage insurance. If you make a down payment of less than 20%, you'll have to pay for Private Mortgage Insurance (PMI). However, unlike the mortgage insurance on an FHA loan, you can typically request to cancel your PMI on a conventional loan once your home equity reaches 20%. This can save you a significant amount of money over the life of the loan.

The primary drawback is stricter qualification criteria. Lenders are taking on more risk, so they look for borrowers with a strong financial history.

Generally, you'll need a credit score of at least 620, though a higher score will get you better interest rates. Lenders also look closely at your debt-to-income (DTI) ratio, which compares your monthly debt payments to your gross monthly income. While some low down payment options exist (as low as 3%), lenders often prefer to see a larger down payment, which can be a barrier for some first-time homebuyers.

Ultimately, a conventional loan is a great option for financially stable borrowers with good credit. It offers flexibility and cost savings that can make it the best choice for many homebuyers.