What is a Conforming Loan?
A conforming loan is one of the most popular types of mortgage. If you’re shopping for a new home, it’s good to get familiar with what it is and what it could mean for you as a borrower to get this type of mortgage.
The Basics
A conforming loan is a mortgage that Fannie Mae or Freddie Mac can purchase because it conforms to or meets their standards. These standards include limits on the amount that can be borrowed.
Fannie Mae and Freddie Mac will buy conforming loans from lenders, packing them together and creating mortgage-backed securities. Mortgage-backed securities are then sold to investors. When a lender sells conforming loans, they can get capital to fund new mortgages.
To be considered conforming and eligible for purchase by Fannie Mae and Freddie Mac, they have to meet certain standards. These standards make them easy for investors to buy and sell.
A conforming loan is a conventional mortgage not backed by the federal government. This contrasts with loans from the FHA, VA, and USDA.
Fannie Mae and Freddie Mac are government entities to provide liquidity and stability to the mortgage markets in the U.S. Fannie Mae primarily buys mortgages from large banks, while Freddie Mac tends to work with smaller, private banks and credit unions.
You don’t work directly with either. You don’t know your loan is being sold to them until you receive an investor letter, but nothing changes on your end when that happens. You’re still making payments to the same entity you were before.
The Standards for a Conforming Loan
The following are the current standards for conforming loans:
• The loan limit is $806,500 for single-family homes in most markets, and the limit is $1,209,750 in higher-cost areas.
• Your credit score has to be at least 620.
• The ideal debt-to-income ratio should be 45% or less.
• When applying for a conforming loan, lenders like to see at least 20% down for a purchase or 20% equity for a refinance. There are instances where Fannie and Freddie will back a conventional loan with as little as 3% down.
• Loan-to-value ratio or LTV should be 80% or lower, ideally, but the LTV max can be anywhere from 95-97% in some cases if you’re a first-time homebuyer or dependent on whether it’s an adjustable or fixed-rate mortgage.
As mentioned, you can qualify for a conforming loan with a down payment of less than 20%, but you have to pay private mortgage insurance (PMI).
What is a Nonconforming Loan?
A nonconforming loan can be a conventional mortgage beyond the loan limits or outside of underwriting guidelines from Fannie Mae and Freddie Mac. Terms of nonconforming mortgages vary quite a bit between lenders. The mortgage rates are usually higher because they’re riskier from the lender’s perspective.
A jumbo loan is one type of non-conforming loan used for properties that cost more than what borrowers could buy and still stay under the loan limits for conforming loans.
The criteria to get a jumbo loan are more stringent. There’s usually a down payment requirement of at least 20% higher credit criteria, more scrutiny of your income, and a higher interest rate.
A loan might be considered nonconforming if the borrower has a low credit score or is making a down payment of less than 20%, although, as mentioned, this doesn’t always make a mortgage nonconforming.
What Are the Pros and Cons of Nonconforming Loans?
The pros of conforming loans from the perspective of a borrower include:
• If you make at least a down payment of 20%, you borrow less money and have more equity when you purchase the home. Your monthly fees can be lower than a mortgage where you put less money down.
• With a down payment of at least 30%, you can avoid paying for PMI, so you can save a few hundred dollars a month, depending on your loan amount.
• Borrowers who can put 20% down and have good credit are likely to qualify for the best interest rates from the lender and the lowest overall monthly payments.
The downsides of a conforming loan include that your DTI ratio has to meet the standards. The maximum DTI ratio is usually 43%, but maybe it can go as high as 50% only if you have other compensating factors like a higher credit score.
If you’re in a high-priced market, especially, the home you want could very easily go beyond the loan limits, so this is also something to think about.
