What is a conforming loan?

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In a Nutshell

When you borrow for a home, you may want a “conforming” loan. A loan is considered conforming when it meets specific guidelines set by two government-sponsored institutions, Fannie Mae and Freddie Mac. Getting a conforming loan can benefit you because eligibility, pricing and features are standardized; loan terms are usually reasonable; and the interest rate may be lower than on a nonconforming loan.
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When you apply for a mortgage, you have lots of loan types to choose from. One common option, which is a good one for many borrowers, is a conforming loan.

A conforming loan gets its name because it “conforms” to specific guidelines set by two government-controlled entities — Fannie Mae and Freddie Mac — that were created decades ago to boost U.S. homeownership. Fannie Mae and Freddie Mac do that by buying mortgages from lenders and either keeping them on their own books or selling them.

Either way, Fannie Mae and Freddie Mac usually pay lenders for the mortgages, after which the lenders can then issue more mortgages and other kinds of loans. The guidelines that Fannie Mae and Freddie Mac put in place are widely accepted by mortgage issuers, making loans that conform to the standards easier to buy and sell. It also makes them easier to package into mortgage-backed securities, which can be traded on certain financial markets (more on that in our Fast Fact below).

The guidelines your lender must comply with to issue conforming loans provide some protection for you. They establish standard rules to qualify for a mortgage, how much you can borrow, and how your loan will be structured. You also benefit because the interest rate on conforming loans is often lower than the rate on nonconforming loans.

But to get a conforming loan, you need to fit within Fannie Mae’s and Freddie Mac’s guidelines, which are specific, but not so strict that there’s only one kind of mortgage available. That means you need to meet minimum credit score requirements and qualify for the amount that you intend to borrow.

Qualifying requirements
  • Minimum credit score of 620 to 700, depending on loan type and size of down payment
  • Debt-to-income ratio that doesn’t exceed 36% or 45%, depending on loan type and down payment
  • Minimum reserves for certain loans
Loan fees
  • Private mortgage insurance is typically required if you borrow more than 80% of the value of the home

The appeal of conforming loans

As a borrower, once you’ve met the requirements for a conforming loan, getting approved can be easier because the bank can sell the loan. Plus, Fannie and Freddie guidelines ensure that lenders follow certain rules for issuing you a loan. Although you still need to be careful about making sure you understand loan terms, you may have a little more peace of mind than you would if you got a nonconforming loan.


Understanding Fannie and Freddie’s role in the secondary mortgage market

Fannie and Freddie have an important job to do: They make it easier for banks to lend or, in technical terms, they “increase liquidity” in the mortgage market. Increased liquidity basically means more money is made available at reasonable terms.

There are two ways Fannie and Freddie acquire loans from mortgage lenders. Lenders can sell a loan directly to Fannie or Freddie and get a cash payment. Or lenders can group a whole bunch of loans together and exchange that group of loans for a mortgage-backed security guaranteed by Fannie or Freddie.

Typically, smaller lenders sell their loans for cash, and Fannie and Freddie turn around and bundle them into a mortgage-backed security, whereas bigger lenders exchange their loans for a mortgage-backed security. Fannie and Freddie guarantee the timely payment of interest and principal on loans bundled into the mortgage-backed security. These mortgage-backed securities are often exchanged with banks and can also be sold to private investors who collect dividends when homeowners pay their mortgages.

If you lived through the 2008 financial crisis, you’ve probably heard the term mortgage-backed security. That’s because in the time leading up to the financial crisis, banks issued a bunch of mortgages to buyers who couldn’t afford them and bundled them up into mortgage-backed securities. The securities were given ratings by credit-rating agencies that made them look like safe investments to investors — but they weren’t.

Fannie, Freddie and investors in mortgage-backed securities, including big banks, suffered major financial losses when homeowners defaulted in record numbers.

How do conforming loans work?

Conforming loans are made by many different lenders, including banks of all sizes, credit unions and online lenders. The big thing conforming loans all have in common is that they must meet requirements for:

  • Credit scores
  • Down payment
  • Debt-to-income ratio (the amount of debt you can have relative to your income)
  • Loan limit

While Fannie Mae and Freddie Mac set guidelines that lenders must obey for conforming loans, lenders have leeway to set their own stricter standards. This means some lenders will be choosier about whom they lend to than others, and some lenders will charge higher or lower interest rates than others.

Conforming loans are not insured or guaranteed by government agencies and, as such, are a type of conventional loan. Alternatives to conforming loans include FHA loans, VA loans and USDA loans, all of which are backed by the U.S. government to promote homeownership and have less-stringent qualifying requirements but often charge higher upfront fees or have higher mortgage insurance costs.

Borrowers need to shop around carefully among different lenders to find the right loan for them.

Conforming loan limits

Loan limits are some of the most important features of conforming loans. You cannot borrow more than the maximum amount set by Fannie and Freddie if you want a conforming loan.

In 2020, the maximum conforming loan limit for one-unit properties in most of the U.S. is $510,400.

But in counties where home prices exceed median values by a specified amount, the amount you can borrow is a multiplier of the median home value in the area. If you’re unsure about the limits in your area, your lender can help you figure out how much you can borrow.

Also, Fannie and Freddie set a cap, so even if home prices are very high in your area, there’s an absolute maximum you can borrow. The maximum loan amount for a conventional conforming loan in most areas is 150% of the baseline limit. In 2020, the ceiling loan limit for one-unit properties in most high-cost areas is $765,600.

If you want to borrow more than the limit set for a conforming loan, you can. In most cases those loans cost more to obtain than conforming loans.

What is the interest rate on a conforming loan?

Interest rates on a conforming loan vary from lender to lender. You also get to choose between a fixed-rate loan or an adjustable-rate loan.

  • A fixed-rate loan is a loan with a set interest rate. Your rate shouldn’t change for the life of the loan, and you will have the same mortgage payment to make for the life of the loan.
  • An adjustable-rate loan has a fluctuating interest rate. Your rate is tied to a benchmark financial index or rate that reflects market conditions. One example is Libor, or the London Interbank Offered Rate, which is a rate that some big banks charge one another for short-term loans.

When you get an adjustable-rate mortgage, or ARM, the rate adjusts on a set schedule. If you have a 5-1 ARM, your interest rate will stay the same for the first five years. After that, the rate can adjust once per year. If you have a 7-2 ARM, your interest rate stays the same for the first seven years and then can adjust once every two years.

With ARMs, there’s usually a maximum amount your rate can increase, as well as a minimum total rate. ARMs typically have a lower introductory interest rate, which makes them attractive to borrowers because payments start out lower than with a fixed-rate mortgage. But you risk that your loan could become unaffordable if interest rates rise more than you can afford.

What are the fees and costs associated with a conforming loan?

Under the guidelines for conforming loans, borrowers with a small down payment must pay for private mortgage insurance, or PMI. You’ll have to pay for PMI if you put less than 20% down on the home. So if a home was valued at $100,000, unless you put down $20,000, you’d have to pay PMI.

PMI premiums are equal to a percentage of the amount you borrowed. If PMI premiums equal 1% of your loan’s value and you borrowed $100,000, you would pay $1,000 annually. PMI premiums vary from lender to lender, and you usually pay premiums monthly.

Mortgage insurance doesn’t protect you. If you’re foreclosed on by your lender for not paying your mortgage, you won’t get any money from the insurer. PMI protects lenders, making sure they get their money back if you default on the home and the house doesn’t sell for enough after a foreclosure to fully repay the lender.

Once you’ve paid your loan balance down to 78% of your home’s value when you bought it, your lender should automatically stop charging you PMI. You can also request that your lender remove PMI as soon as you’ve paid enough that you only owe 80% or less of your home’s value.

You may also have to pay other fees, which vary by lender, so shop around.

Applying for a conforming loan

Many lenders across the country make conforming loans, so you can apply with many different financial institutions. In fact, you should shop loans with several different lenders so that you can compare rates and terms.

Who can qualify?

To qualify for a conforming loan, you’ll need to meet specific requirements. Those requirements vary based on whether you’re buying or refinancing a loan for a primary home, a secondary home or an investment property.

The key factors that determine if you can qualify include:

  • Your loan-to-value ratio: This refers to the amount you borrow versus the value of your home. If you have an 80% loan-to-value ratio, you’d borrow no more than 80% of what your home is worth. The lower your down payment, the higher your loan-to-value ratio.
  • Your credit scores: Higher credit scores mean you’ll stand a greater chance of being approved, even with a low down payment.
  • Your reserves: For some types of loans, you’re required to have at least six months of assets in reserve.
  • Your debt-to-income ratio: This is the total amount of monthly debt payments you have, relative to your monthly gross income. It includes your mortgage payment.
  • The number of units: There are different requirements for a single-family home versus a two-unit property or a three- or four-unit property.

Fannie Mae has an eligibility matrix showing the specific requirements you must fulfill for each kind of loan. For example, let’s say you want to buy a one-unit property and put down just 5%. You would need a minimum credit score of at least 680 if your debt-to-income ratio was below or equal to 36% — or a minimum credit score of at least 700 if your debt-to-income ratio was above 36% but below or equal to 45%.

Bottom line: Is a conforming loan right for you?

If you’re borrowing for a home, consider a conforming loan. Conforming loans can come with a lower interest rate, plus the peace of mind of knowing your lender meets Fannie and Freddie guidelines.

Caps on borrowing make it tough to buy a home that exceeds conforming loan limits, and qualifying requirements are arguably stricter than those for an FHA, VA or USDA mortgage — so not everyone can get a conforming loan. Requirements and loan terms vary by lender, so be sure to shop around to find the right loan for you.

About the author: Christy Rakoczy Bieber is a full-time personal finance and legal writer. She is a graduate of UCLA School of Law and the University of Rochester. Christy was previously a college teacher with experience writing textbo… Read more.