10 Surprising Conventional Loan Drawbacks You Might Not Know About

Understanding the Limitations of Conventional Loans

Conventional loans—those that follow Fannie Mae and Freddie Mac standards—are widely considered the gold standard of mortgage lending. However, they aren’t always the best option. Certain restrictions, costs, and requirements may make other loan types more appealing.

Before choosing a conventional mortgage, here are 10 surprising drawbacks to consider and possible alternatives that may better suit your needs.

1. Private Mortgage Insurance (PMI) Is Required With Less Than 20% Down

A common misconception is that conventional loans require a 20% down payment. While 3% and 5% down options exist, they come with private mortgage insurance (PMI)—an added monthly expense.

✔ PMI adds to your mortgage payment, sometimes $100 or more per month. ✔ FHA loans may offer lower insurance costs for borrowers with credit scores below 740. ✔ VA loans require no PMI and allow 0% down for eligible borrowers.

2. Stricter Credit Score and Debt-to-Income (DTI) Requirements

Conventional lenders generally require: ✔ A 620+ credit score (FHA allows 580 or even 500 with a 10% down payment). ✔ A max DTI ratio of 43-45% (FHA allows up to 56.9% in some cases).

If your credit score is low or debt is high, FHA and VA loans may be better alternatives.

3. Higher Interest Rates for Lower Credit Scores

Even if you qualify for a conventional loan, you may pay higher interest rates if your credit score is below 740.

✔ FHA loans often offer more competitive rates for borrowers with lower credit scores. ✔ VA and USDA loans typically provide lower rates without risk-based pricing.

4. Conventional Loan Limits Could Impact Your Purchase

The Federal Housing Finance Agency (FHFA) sets a maximum loan limit for conventional mortgages, which may restrict borrowing power in high-cost areas.

✔ Jumbo loans are required for amounts above the FHFA limit. ✔ VA loans have no official loan limit, only based on affordability.

5. Longer Waiting Periods After Foreclosure, Bankruptcy, or Short Sale

If you’ve experienced a significant credit event, conventional loans require longer wait times: ✔ Foreclosure: 7 years (FHA: 3 years, VA: 2 years). ✔ Bankruptcy: 2-4 years (FHA/VA: 1-2 years). ✔ Short Sale: 4 years (FHA: 3 years, VA: 2 years).

Government-backed loans provide faster recovery options for past financial hardships.

6. 3% Down Loans Are Limited to First-Time or Low-Income Buyers

Certain 3% down options (e.g., Conventional 97, HomeReady) only apply to first-time buyers or those meeting income limits.

✔ FHA loans allow 3.5% down with no income limits. ✔ VA loans offer 0% down with no restrictions.

7. Larger Down Payments Are Required for Multi-Unit Homes

While conventional loans require 5% down for single-family homes, multi-unit properties require at least 15% down.

✔ FHA allows 3.5% down on 2-4 unit properties if you live in one unit. ✔ VA loans offer 0% down on multi-unit homes for eligible borrowers.

8. Conventional Fixer-Upper Loans Have Lower Borrowing Limits

Conventional renovation loans (e.g., HomeStyle, CHOICERenovation) cap borrowing at 97% of the after-repair value.

✔ FHA 203(k) loans allow borrowing up to 110% of the improved home value. ✔ FHA also requires just 3.5% down, even for renovations.

9. Higher Closing Costs Compared to Some Government-Backed Loans

Conventional loans often come with higher closing costs, including: ✔ Origination fees (often 1% of the loan amount). ✔ PMI upfront fees, if applicable. ✔ Higher required reserves for investment properties or multi-unit homes.

✔ FHA loans allow seller-paid closing costs up to 6%. ✔ VA loans limit borrower closing costs, reducing out-of-pocket expenses.

10. Conventional Loans Have Stricter Employment and Income Verification

Self-employed borrowers and those with non-traditional income may find conventional loans harder to qualify for due to: ✔ Stricter income documentation requirements. ✔ Higher scrutiny for variable or gig-economy income. ✔ Need for 2+ years of consistent income history.

✔ FHA and VA loans often provide more flexibility for self-employed applicants. ✔ Bank statement loans (alternative mortgage options) may be better suited for gig workers and entrepreneurs.

Should You Choose a Conventional Loan?

While conventional loans are popular, they aren’t always the best choice. Before committing, consider FHA, VA, or USDA loans, which may offer lower costs, better flexibility, and easier qualification.

✔ Compare loan options carefully. ✔ Work with a mortgage expert to find the best loan for your situation. ✔ If you're unsure, explore government-backed alternatives that may provide better rates and benefits.