When you are shopping for mortgages, you may come across the term “conforming loan.” Is that something different than a conventional loan? Does this matter to you as a borrower? Here’s a quick explanation of conforming loans.
Fannie Mae and Freddie Mac
Although all conforming loans are conventional loans, not all conventional loans are conforming. A conforming loan is any conventional loan that meets certain criteria set by the Federal Housing Finance Agency. The main feature of these criteria is the limit on loan size. In most areas of the country in 2020, that limit is $510,400 for a single-family home. In higher-cost markets such as San Francisco and New York, the cap is $765,600. Loans that exceed these dollar caps are called non-conforming or jumbo loans.
Each year the FHFA surveys lenders to gather current data on home sales prices, interest rates, and terms, then calibrates the conforming loan standards accordingly. Price caps vary down to the county level.
The size of a loan is not the only factor that makes it conforming. Other criteria set parameters on the loan-to-value ratio, the borrower’s debt-to-income ratio and credit score, and the amount of the down payment.
Two quasi-federal agencies, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Association (Freddie Mac), will agree to insure conforming loans offered by private lenders. Fannie and Freddie often purchase these loans from lenders to offer to the private investment markets in bundles. This replenishes money to the lender to loan out to other borrowers. Jumbo loans are not eligible for Fannie or Freddie backing.
What is the benefit of a conforming mortgage?
Conforming mortgages typically offer lower interest rates than non-conforming loans because they are less risky. Additionally, with a conforming mortgage, you may get some wiggle room on the down payment amount and the credit score needed to qualify. Keep in mind, though, that If you put down less than 20 percent of a home’s purchase price, you’ll be required to buy private mortgage insurance (PMI) to protect the lender in the event you default. A monthly PMI payment uses money that could otherwise be used to build equity in the house.
Because they are relatively easy to qualify for and offer lower interest rates, conforming loans can offer substantial benefits to borrowers.
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