Conforming Mortgage Definition

What Is a Conforming Mortgage?

A conforming mortgage is a home loan that meets both the qualification standards of Fannie Mae and Freddie Mac and the loan limits set by the Federal Housing Finance Agency (FHFA).

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What Is a Conforming Mortgage?

conforming mortgage

Conforming mortgages are loans that meet two standards:

  1. Fannie Mae and Freddie Mac’s guidelines[1] for financing single-family homes.
  2. The loan limits are set by the Federal Housing Finance Agency (FHFA).

Fannie Mae and Freddie Mac incentivize lenders who obey their rules by buying the home loans they issue. These government-sponsored enterprises (GSEs) repackage the mortgages into securities and sell them to investors. Thanks to these GSEs, conforming loan lenders can extend credit to homebuyers more easily and get mortgages off their balance sheets.

These guidelines are as follows:

  • The loan must not go over the dollar cap set by the federal government in the county where the property is located.
  • The borrower must pay the minimum down payment, which could be as low as 3% of the property’s price[2].
  • The borrower must have a minimum credit score, which could be anywhere from 620 to 700, and determined by the type of mortgage and the size of down payment.
  • The borrower must have a debt-to-income ratio of 36% to 45%[3].
  • The borrower must satisfy income, employment, and cash reserve requirements.

Since conforming loan lenders absorb less risk, they can afford to lower their interest rates.

Difference With a Nonconforming Mortgage

On the other hand, nonconforming mortgages have different qualification standards because they exceed the loan limits set by the FHFA. That is why nonconforming home loans also go by the name “jumbo mortgages.”

Since borrowers are asking for more money to take out a nonconforming loan, they have to meet stricter requirements.

Due to the amount, nonconforming loans are too large for Fannie Mae and Freddie Mac to buy. Without the backing of GSEs, nonconforming lenders are motivated to charge higher interest rates to make up for the greater risk they have to take.

What Is the Difference Between Conforming and Conventional Loans?

Conforming loans and conventional loans are two different terms. For starters, all conforming mortgages are conventional, but not all conventional mortgages are conforming.

By definition, a conventional loan is a loan that is not insured (or backed) by the federal government.

Because Fannie Mae and Freddie Mac are technically private corporations, even if they answer to the FHFA, any loan they back is considered a conventional loan.

In fact, nonconforming mortgages are conventional loans themselves because no third party sets the qualification guidelines for these home loans. The lenders—which are generally private entities—alone call the shots. They can lend as much as they want and to whomever they want.

Is an FHA Loan a Conforming Loan?

An FHA (Federal Housing Administration) loan program[4] could never be a conforming loan.

As mentioned, a conforming loan is conventional. And all government-backed mortgages, including FHA loans, are not.

While FHA and conforming mortgages do not fall under the same category, both of them can help American consumers, especially millennials[5], overcome some of the usual obstacles to owning a house.

More millennials tend to choose conforming mortgages over FHA ones[6]. One of the possible reasons is the slightly lower down payment requirement conforming home loans have.

Subprime Loan vs. Conforming Loan

A subprime loan is offered to someone with a credit score below 620. It comes with high interest to compensate the lender for extending credit to a borrower whose record suggests that the likelihood of late payment and default is high.

Since the minimum credit score requirement of conforming mortgages is 620, they could never be tied to subprime interest rates.

Borrowers with credit scores of 620 or above could be considered near-prime, prime, or super-prime[7]. No matter what category these homebuyers fall into, they are in a comfortable position to negotiate for favorable interest as a reward for their creditworthiness.

What Is the Conventional Conforming Loan Limit?

The right answer depends on two things: the time of the year and the location of the house. Here is a breakdown of each aspect.

Time of Year

conforming mortgage calendar

The federal government sets the conforming loan limits annually using the House Price Index[8]. In the past, policymakers relied on the Monthly Interest Rate Survey[9].
The FHFA adjusts the maximum conforming loan caps to reflect the change in the average home prices across the United States from the previous year.

This federal agency announces the new loan ceilings in the fourth quarter of the current year based on house prices for the past four quarters.

Moreover, there are two types of conforming loan limits: the baseline limit and the high-cost area limit.

The first one applies to most of the U.S., whereas the second is reserved for select counties or county-equivalents, particularly in areas where the local median home value is higher than the baseline limit by 115%.

Location

conforming mortgage location

The ceiling of the conforming loan limits in expensive areas is 150% of the baseline limit. The home loans issued using the higher maximum limit aptly are called super conforming loans[10].

Due to the provisions under the Housing and Economic Recovery Act of 2008[11], Alaska, Hawaii, Guam, and the U.S. Virgin Islands follow the higher maximum conforming loan amount cap.

Furthermore, the conforming loan limits can increase or decrease. They can also stagnate, like what happened from 2006 to 2016 when the baseline limits for single- and multi-unit properties remained unchanged at $417,000[12].

The FHFA may decide to change the limits in some counties and county-equivalents only.

When the conforming loan ceilings are likely to jump, some lenders even begin to approve larger loan applications before the federal agency makes an official announcement[13].

Takeaways

  • A conforming mortgage is a home loan that meets the local loan limit set by the FHFA and satisfies the funding guidelines of Fannie Mae and Freddie Mac.
  • Unlike FHA loans, conforming loans, together with other mortgages not backed by the government, are a type of conventional loan.
  • Maximum conforming loan limits vary by location and may change every year to reflect the latest average home price in different counties.

Sources

  1. Consumer Financial Protection Bureau. (2016.) What are Fannie Mae and Freddie Mac? Retrieved from https://www.consumerfinance.gov/ask-cfpb/what-are-fannie-mae-and-freddie-mac-en-1959/
  2. Grace, M. (2021.) Conforming Loan Limits In 2021. Rocket Mortgage. Retrieved from https://www.rocketmortgage.com/learn/conforming-loan-limits
  3. Fannie Mae. (2021.) What is the maximum DTI ratio allowed? Retrieved from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-6-Liability-Assessment/1064501811/What-is-the-maximum-DTI-ratio-allowed.htm
  4. Sloan, K. (2018.) The Different Types of FHA Loans. LendingTree. Retrieved from https://www.lendingtree.com/home/fha/the-different-types-of-fha-loans/
  5. Choi, J., Goodman, L., & Zhu, J. (2018.) The state of millennial homeownership. Urban Institute. Retrieved from https://www.urban.org/urban-wire/state-millennial-homeownership
  6. Robertson, C. (2018.) Millennials Favor Conventional Mortgages Over FHA. The Truth About Mortgage. Retrieved from https://www.thetruthaboutmortgage.com/millennials-favor-conventional-mortgages-over-fha/
  7. Proctor, C. (2021.) Prime vs. Subprime Loans: How Are They Different? myFICO. Retrieved from https://www.myfico.com/credit-education/blog/prime-vs-subprime-loans
  8. Liberto, D. (2021.) House Price Index (HPI). Investopedia. Retrieved from https://www.investopedia.com/terms/h/house-price-index-hpi.asp
  9. Hall, P. (2019.) FHFA to End Monthly Interest Rate Survey. NMP. Retrieved from https://nationalmortgageprofessional.com/news/71185/fhfa-monthly-interest-rate-survey
  10. Freddie Mac. (n.d.) Super Conforming Mortgages. Retrieved from https://sf.freddiemac.com/working-with-us/origination-underwriting/mortgage-products/super-conforming-mortgages
  11. Library of Congress. (2008.) HOUSING AND ECONOMIC RECOVERY ACT OF 2008. Retrieved from https://www.congress.gov/110/plaws/publ289/PLAW-110publ289.pdf
  12. HSH. (2020.) A History of Conforming (Fannie/Freddie) Loan Limits. Retrieved from https://www.hsh.com/mortgage/a-history-of-conforming-fanniefreddie-loan-limits.html
  13. Volkova, M. (2021.) PennyMac, UWM raise conforming loan limit ceiling. HousingWire. Retrieved from https://www.housingwire.com/articles/pennymac-uwm-raise-conforming-loan-limit-ceiling/

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