What Is A Conforming Loan And How Does It Work?
As you shop around for a mortgage, it’s important that you’re aware of the types of loans available to you. However, understanding all that mortgage industry lingo can feel a little overwhelming. One potentially confusing term you might hear tossed about is the term “conforming loan.”
To make your home buying experience a bit simpler, let’s discover what exactly a conforming loan is. We’ll also explore how you might get one, and the conforming loan limits for 2024.
Conforming Loan Definition
A type of home loan you’ll likely encounter when shopping for a mortgage, a conforming loan is any mortgage that meets the standards for purchase by government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.
The Federal Housing Finance Agency (FHFA) issues the rules to which qualified loans must conform. Conforming loan requirements pertain to how much you can borrow, the property types you can purchase and whether you have the ability to repay the loan.
Additionally, lenders must make disclosures throughout the loan process to keep borrowers informed about their costs.
Conforming Loans Vs. Non-Conforming Loans
A loan that doesn’t meet the criteria to be purchased by Fannie Mae or Freddie Mac is known as a non-conforming loan. One type of non-conforming loan is a jumbo loan.
Jumbo loans are loans that exceed the conforming loan limit. Typically, the interest rate and required down payment are higher on this type of non-conforming loan. The borrower eligibility guidelines for non-conforming loans vary across lenders.
More common non-conforming loans are government-insured loans that are backed by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA) and the U.S. Department of Agriculture, respectively.
Other types of non-conforming loans are geared toward borrowers who don’t meet conforming loan standards. In many cases, self-employed or seasonal workers have a hard time providing adequate verification of their income and must rely on a non-conforming loan to purchase a home.
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How Do Conforming Loans Work?
When you buy a house, you might think your mortgage stays with your lender, who waits patiently until you finish paying it back. However, for most conventional loans – loans backed by a private lender, not the federal government – borrowing guidelines are made by the GSEs. The GSEs – Fannie Mae and Freddie Mac – buy loans from lenders that meet their guidelines. This gives lenders a constant flow of money that allows them to continue lending.
Fannie and Freddie don’t directly make loans. Instead, the private sector is incentivized to meet their consumer protection requirements because they know the GSEs have specified criteria for the types of loans they’ll buy since they’re taking on the risk by purchasing the mortgage. Fannie and Freddie won’t buy any loans that fail to meet their requirements.
How The Rules Work
The law doesn’t mandate “conforming” and “non-conforming” rules for all lenders and loans. Rather, it incentivizes lenders that operate by making loans and then selling them to Fannie and Freddie to continue this practice by conforming to their requirements.
These requirements have to do with how much you can borrow, the types of properties you can purchase and whether you have the ability to repay the loan. Mortgage loan guidelines – such as those that require a minimum credit score or maximum debt-to-income ratio (DTI) as a prerequisite for loan approval – exist to prevent lenders from lending money to borrowers who can’t afford their loan payments.
The guidelines help protect a borrower from taking on more debt than they can manage, and they protect the lender from accepting too much risk.
See rates, requirements and benefits.
What Are Conforming Loan Limits?
Conforming loan limits are monetary caps set by the Federal Housing Finance Agency that limit how large of a loan a borrower can get and still meet Fannie Mae and Freddie Mac’s standards for the purchase of a house. That dollar amount is determined each year by the FHFA. The national conforming loan limit for 2024 is $766,550. However, in many high-cost areas, there’s simply no housing to be had at the upper limit. In these areas, the limit is $1,149,825 for a one-unit property.
For a conventional loan to be considered a conforming loan, the loan amount must be lower than the limit set by the FHFA.
Conforming Loan Limits Example
Let’s say you want to buy a one-unit home in Wayne County, Michigan, for $250,000 and use a conventional loan of $200,000 to do so. Because your loan is well under the loan limit of $766,550, your mortgage will be considered a conforming loan.
On the other hand, if you want to buy the same single-family home in San Francisco, it’s not unheard of to spend around $1.1 million. The conforming limit in San Francisco is $1,149,825. A 20% down payment would equal $220,000, meaning you’d need a $880,000 loan. However, with a conforming loan, you can sometimes make a down payment as low as 3% of the purchase price, so you may need no more than $33,000.
Other Requirements For A Conforming Mortgage
Though loan size is a big part of determining what is and isn’t a conforming loan, Fannie Mae and Freddie Mac, along with the FHFA, have additional guidelines that establish the loans that Fannie and Freddie will and won’t purchase. For example:
- It has to be a single-family home. While some people may think of a single-family home as a home where only one family lives, the FHFA has a different definition. It defines a single-family home as any home with one to four units.
- The borrower must have the ability to repay. To qualify for a conforming loan, you’ll generally need a credit score of at least 620, a DTI below 50% and a maximum loan-to-value ratio (LTV) of 97% (meaning you’ll need to put at least 3% down).
- Disclosures: Certain disclosures applying to all mortgage loans, including conforming loans, will be made to borrowers as they proceed through the mortgage application process. Sometimes referred to as “TILA-RESPA” (Truth in Lending Act and Real Estate Settlement Procedures Act of 1974).
See rates, requirements and beneifts.
Benefits Of Conforming Loans
Having a loan that conforms to guidelines set by Fannie Mae and Freddie Mac carries significant advantages, which we’ll review momentarily.
The Ability To Shop Around
Conforming loans are offered by many lenders, giving you the opportunity to compare services and prices. Moreover, because of the required disclosures, you’ll have a complete breakdown of a lender’s estimated costs shortly after preapproval, which makes it easier to compare multiple preapproval offers.
Consumer Protection Guidelines
Conforming loans have standardized guidelines and forms meant to protect the borrower and lender from poor lending practices. Lenders can no longer offer mortgages without proper verification of income, assets and credit history, and they can’t make loans to borrowers who have no way to repay them.
The Opportunity To Remove Mortgage Insurance
If you make a down payment of 20% or more, you don’t have to pay for private mortgage insurance (PMI) at all on a conventional conforming loan. If you do end up paying mortgage insurance for a period of time, you can request removal when you reach 20% equity if it’s based solely on the payments being made and not the home improvements. If home improvements or value increases are involved, it gets more complex. PMI is automatically removed once you reach 22% equity compared to the original loan.
Occupancy Flexibility
Conventional conforming loans are the only home loans you can use to buy a vacation home. Additionally, conforming loans are the only ones you can use to buy a non-owner-occupied residential investment property.
Down payments and interest rates are slightly higher for second homes and rental properties, but they’re an option.
FAQ
The following are a few frequently asked questions about conforming loans.
Conforming loans fall under the umbrella of conventional loans, which are loans funded by a private lender rather than an agency of the federal government.
While all conforming loans are conventional (not insured by a government agency), not all conventional loans are conforming. For example, jumbo loans are conventional, but they don’t conform to the limits set by the FHFA or the standards of Fannie and Freddie.
The Bottom Line
Conforming loans – which represent the largest segment of home loans – are typically preferred by buyers who want to avoid some of the limitations associated with government-backed loans, which are designed for and mostly limited to certain buyer demographics.
Conforming loans can also be an attractive option to borrowers who simply don’t need or qualify for a jumbo loan.
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