Conventional Loans vs. Unconventional Loans vs. Nontraditional Loans: Which One Is Right for You?
The Bottom Line
This guide compares conventional, unconventional, and nontraditional loans, explaining their key differences, eligibility requirements, and pros and cons. By understanding these mortgage options, homebuyers can determine which loan type best suits their financial situation and homeownership goals.
When it comes to buying a home, choosing the right mortgage is just as important as finding the perfect house. But with so many loan types floating around, such as conventional, unconventional, and nontraditional, it’s easy to get overwhelmed.
This guide will break down each loan type, how they work, their pros and cons, and which one might be the best fit for you and your situation.
What Is a Conventional Loan?
A conventional loan is the standard, go-to mortgage most homebuyers think of when they start looking for financing. It follows the guidelines set by Fannie Mae and Freddie Mac–the two government-sponsored entities that help regulate the mortgage industry.
Conventional loans can be “conforming” or “non-conforming.”
A conforming loan is a mortgage that falls within the loan limits and other guidelines set by Fannie Mae and Freddie Mac and their overseer, the Federal Housing Finance Agency (FHFA).
Conforming loan limits start at around $800,000 and can be more than $1 million in high-cost areas. Check current limits here.
Non-conforming loans exceed the conventional loan limits or otherwise offer features outside rules established by Fannie Mae and Freddie Mac. Because these loans are not eligible for purchase by these agencies, they typically come with higher interest rates and larger down payment requirements compared to conforming loans.
Key Features of Conventional Loans
Some important aspects of conventional loans are that they typically require:
A higher credit score (usually 620 or above).
A down payment of at least 3%, though 5% is more common, and 20% to avoid private mortgage insurance (PMI).
Fixed or adjustable interest rates, with loan terms generally ranging from 15 to 30 years.
Mortgage borrowers who qualify for conventional loans often benefit from lower interest rates and fewer fees compared to nontraditional loans, making them a popular choice for homebuyers with good credit and financial stability.
Pros of Conventional Loans
Lower interest rates: A lower rate results in reduced monthly payments and lower overall costs throughout the life of the loan.
Standardized underwriting process: A structured underwriting and approval process helps ensure consistency, potentially minimizing unexpected hurdles during your loan application.
Cancelable PMI: No mortgage insurance is required if you put 20 percent down.
Flexible terms: More versatility in loan terms, including 15-year, 20-year, and 30-year options.
Added safeguards: May offer specific protection during financial hardships, such as the foreclosure moratorium implemented by the federal government during the pandemic.
Cons of Conventional Loans
Stricter qualification requirements: It may be challenging to qualify if you have a low income, poor credit score, or a high debt-to-income (DTI) ratio.
Higher down payment: Compared to some government-backed loans such as VA and USDA, conventional loans typically require more money down.
Risk of higher rates: Unlike government-backed loans that typically offer more competitive rates for mortgage borrowers with lower credit scores, conventional loan interest rates depend heavily on your credit score, meaning lower scores result in higher costs.
If you have good credit, a steady income, and at least 5 percent down, a conventional loan might be the best option. However, if those requirements seem difficult to meet, unconventional loans might be worth exploring.
Related: Types of conventional loans and their uses
What Is an Unconventional Loan?
An unconventional loan is a type of mortgage that doesn’t follow guidelines set by Fannie Mae or Freddie Mac. Instead, these loans are backed by the government. The term 'unconventional loans' is not a widely recognized industry category. Some use it to refer to nontraditional loans, while others use it for government-backed loans. In this guide, 'unconventional loans' refers to government-backed loans like FHA, VA, and USDA loans.
Unconventional loans typically come with lower credit and down payment requirements, making them ideal for first-time buyers or those with financial limitations.
Types of Unconventional Loans
FHA Loans
A government-backed mortgage with a low down payment requirement, insured by the Federal Housing Administration (FHA), a division of the U.S. Department of Housing and Urban Development (HUD). FHA loans are well-suited for mortgage borrowers with limited savings for a down payment or lower credit scores (as low as 500 with 10% down). Learn more about FHA loans below:
VA Loans
A mortgage backed by the U.S. Department of Veterans Affairs (VA) to help veterans achieve affordable homeownership. VA loans are designed for veterans and active military members, requiring no down payment and no private mortgage insurance. Learn more about VA loans below:
USDA Loans
A government-backed loan insured by the U.S. Department of Agriculture’s Rural Housing Program, designed to help low- and moderate-income households buy homes in eligible rural areas. USDA loans are a zero-down loan for buyers in rural and suburban areas, though income limits apply. Learn more about USDA loans below:
HUD Section 184
A loan option with a low down payment that is backed by HUD’s Office of Native American Programs in an effort to make homeownership more affordable for Native Americans. The loan backing assures the lender that in the event of foreclosure, its investment will be repaid in full.
Pros of Unconventional Loans
Lower down payment requirements: Some loans, like VA and USDA, offer zero percent down financing.
Easier qualifying requirements: Compared to conventional loans, most government-backed loans have more relaxed underwriting standards, including lower credit score and debt-ratio requirements.
Government-backed protection: Loans insured by the FHA, VA, or USDA provide added security for lenders, making it easier for applicants to get approved despite credit or financial challenges.
Lower interest rates for some borrowers: Government-insured loans often provide more competitive interest rates compared to conventional loans, especially for borrowers with lower credit scores.
No PMI for some loans: Unlike conventional loans, VA loans and USDA loans do not require mortgage insurance with less than 20% down, which can reduce monthly costs for eligible borrowers.
Cons of Unconventional Loans
Upfront costs and fees: While VA and USDA loans do not require mortgage insurance, they do require fees like the VA funding fee and the USDA loan guarantee fee, which serve a similar purpose as PMI. They are generally lower than PMI, though.
Stricter property requirements: Some programs, like VA, USDA, and FHA loans, have specific property standards that limit the type of home you can purchase, potentially reducing your options.
Loan limits: FHA loans have loan limits that may not be sufficient in high-cost housing markets. USDA loans do not have loan limits but instead determine eligibility based on income limits, typically capped at 115% of the area’s median income, which may disqualify higher-earning borrowers.
Longer approval process: Due to additional government regulations and paperwork, USDA loans can sometimes take longer to process compared to conventional mortgages.
Occupancy restrictions: Many government-backed non-conventional loans require the borrower to use the home as their primary residence, making them unsuitable for investment properties or second homes.
If you are a first-time homebuyer or need more flexible approval requirements, unconventional loans can be a great alternative. However, for those who do not fit into traditional lending requirements, nontraditional loans may be the best option.
What Is a Nontraditional Loan?
A nontraditional loan is a mortgage that does not fit the standard lending model. These loans are often used by self-employed borrowers, real estate investors, or those who do not meet traditional lender requirements.
Examples of Nontraditional Loans
Bank Statement Loans
Instead of using paycheck stubs, W-2s or tax returns, lenders verify income through bank deposits, typically over 12-24 months, which is ideal for self-employed buyers.
Interest-Only Loans
Borrowers pay only interest for the first few years, then start paying principal later, making payments lower initially but possibly more expensive long-term.
Seller Financing
Buyers make payments directly to the home seller instead of going through a bank, which works best for off-market deals.
Balloon Loans
Loans that start with lower monthly payments but in return, require a large lump sum at the end of the term. These are generally considered high-risk and may not be suitable for many homebuyers.
Pros of Nontraditional Loans
Self-employed borrowers: Beneficial for self-employed buyers who cannot provide traditional income documentation.
Flexible loan terms: Allow for alternative income verification.
Easier to buy a home: Can make homeownership possible when other loan types are unavailable.
Cons of Nontraditional Loans
Higher interest rates: Typically higher rates and fees compared to traditional loans.
Greater risk: Added risk involved for borrowers, especially if a large lump-sum payment is required at the end of the loan term.
Less regulation: Lenders can set their own rules and terms. They also lack federal protections for the borrowers.
If you are self-employed, an investor, or have nontraditional income sources, these loans might be the best option for financing a home.
Conventional vs. Unconventional vs. Nontraditional Loans: Key Differences And Which to Choose
The primary differences between conventional, unconventional, and nontraditional loans often come down to credit requirements, down payments, and approval processes.
Feature | Conventional Loans | Unconventional Loans | Nontraditional Loans |
Credit Score | 620+ | As low as 500 | Varies by lender |
Down Payment | 3 - 20% | 0 - 3.5% | No standard limits |
Approval Process | Stricter | More flexible | Case-by-case basis |
Best For | Good credit & stable income | First-time buyers & lower credit scores | Self-employed or alternative financing needs |
Conventional loans typically require higher credit scores, making them a better fit for borrowers with strong financial histories. In contrast, unconventional and nontraditional loans offer more flexibility, catering to individuals who may not meet the stricter credit requirements of traditional financing.
Similarly, down payment expectations vary—while conventional loans usually require 5% to 20% down, government-backed loans like VA and USDA loans can provide financing with as little as zero down, making homeownership more accessible to those who qualify.
Another significant factor is loan limits. Conventional and FHA loans have set borrowing caps, which can limit purchasing power in high-cost markets. However, jumbo loans— a type of non-conforming conventional loan— and certain nontraditional mortgage options allow borrowers to exceed these standard limits, making them a popular choice for luxury or high-priced properties.
The approval process also differs between loan types. Conventional loans adhere to strict lending guidelines, while unconventional loans benefit from government backing, which can provide more flexibility in approval.
Nontraditional loans, on the other hand, may require custom agreements between lenders and borrowers, allowing for unique terms that don’t always fit within traditional lending frameworks.
Common Myths About Loan Types
There’s often misconceptions associated with getting a mortgage.
20% down: While a down payment of 20% is necessary to avoid PMI, you may qualify for just 5% down, or even just 3%. Related: What's the average down payment on a house?
High rates for unconventional loans: Government-back loans are known for having competitive interest rates. VA loans often come with lower interest rates than many conventional loans.
Nontraditional loans are risky: Nontraditional loans do tend to be riskier than traditional loans because they lack federal protections and usually have higher interest rates than traditional loans. However, some nontraditional loans, like bank statement loans, can be extremely beneficial for self-employed buyers that can’t show adequate income via paycheck stubs or W-2s.
How to Choose the Right Loan for Your Situation
With so many loan programs to choose from, it can seem difficult to know which one best suits your needs.
Here are a few helpful tips:
Assess Your Finances: Review your credit score, existing debts, and income to determine which mortgage options you qualify for. If you have fair credit and little savings, a government-backed loan (FHA, VA, or USDA) might be best. If you have strong credit and a low debt-to-income ratio, a conventional loan could offer better rates.
Check for Eligibility Benefits: VA loans provide the most favorable terms for veterans and active-duty military, while USDA loans offer great options for rural homebuyers with no down payment required.
Consider Your Long-Term Plans: If you’re buying a forever home, a fixed-rate mortgage ensures predictable payments. However, if you plan to sell or refinance in a few years, an adjustable-rate mortgage (ARM) could offer lower initial rates.
Consult a Mortgage Expert: Your home is one of the biggest purchases of your life, so don’t make a decision alone. A mortgage professional can help you compare options and find the best fit for your financial situation.
Final Thoughts
The right loan helps you achieve homeownership while keeping your finances secure. Understanding your options is key to making the best financial decision, whether you choose a conventional, unconventional, or nontraditional loan.
Speak with a knowledgeable mortgage lender to explore different loan types and which is best for you and your family.
