Conforming Loans: What You Need to Know
Buying a home can be an exciting — and exhausting — adventure, especially if you’re trying to untangle the different types of mortgage loans that may be available to you. One of the most fundamental concepts is knowing the differences between a few broad terms, such as conforming and non-conforming loans, and how they apply to conventional mortgages or those insured by government agencies.
In this article we’ll talk about the benefits of a conforming loan — and its limits — and whether one is right for you.
What is a conforming loan?
In the simplest of terms, a conforming loan is a mortgage loan that meets guidelines and limits set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), both of which are government-supported enterprises.
The two organizations purchase home loans from lenders and package them into securities. Those bonds typically have a guarantee that Fannie and Freddie will pay investors if a borrower defaults. Lenders use the money from selling loans to make more loans and other investments.
But there’s a limit to the size of these loans — in November, the Federal Housing Finance Agency (FHFA) announced that it would raise loan limits to keep up with rising home price appreciation from $424,100 to $453,100 in most parts of the U.S. For high-cost areas, the limit was raised to $679,650. Look up your county’s limit here.
Conforming versus non-conforming. A non-conforming loan, therefore, is a loan that doesn’t adhere to these loan limits. They are often referred to as “jumbo” mortgages, because they exceed the amounts listed above. A jumbo mortgage typically requires:
- A higher down payment, usually 20% or more.
- Excellent credit — 740 or higher.
- Lower debt-to-income ratio — 45% or lower.
Non-conforming loans may even have higher interest rates and fees; they allow a consumer to borrow more money but often come at a higher price.
What are the benefits of a conforming loan?
Conforming loans are beneficial for most buyers because, with excellent credit, they qualify for lower interest rates and therefore lower monthly payments.
LendingTree Chief Economist Tendayi Kapfidze noted that the most significant risk with any loan is lack of understanding. “Once you get a loan, the risk is all with the lender. [For borrowers,] the risk with conforming loans is just better understood than non-conforming loans. This was proven out during the financial crisis.”
That’s why Kapfidze encourages consumers to do their homework before filling out any loan application.
“Different lenders are going to give different prices and interest rates to the same borrower,” he said. “Even within the guidelines, lenders choose which market to address. If they are interested in certain areas of the market, they may price more aggressively. However, since you don’t know each lender’s strategy, talk to more than one. There may be a lender that fits better with your financial picture.”
Conforming, conventional — terms that sound alike, but mean different things
Now that you understand the difference between conforming and non-conforming loans, lenders may introduce another term: conventional loans. A conventional loan can either be conforming or non-conforming.
In your search for a lender, keep in mind that the term “conforming” is an umbrella term that covers several types of loans. For example, both fixed rate and variable rate mortgages can fall into the “conforming” category, but they operate very differently. Knowing that a variable rate loan lets you take advantage of interest rate drops, at the risk of changing monthly payments, and that a fixed rate offers the security of the same amount every month, but at the loss of potential savings should the market drop, will allow you to evaluate what type is right for you.
Conventional loans are mortgages made by private lenders that are not guaranteed by government agencies such as the Federal Housing Administration or Department of Veterans Affairs. About half of such loans are conforming — all non-conforming loans are conventional loans.
How to find a conforming mortgage lender
Shopping around for a lender may help ensure you get the best terms possible. LendingTree created the Mortgage Rate Competition Index to show consumers how much they can save by comparing interest rates. Consumers can compare rates without impacting their credit score by using the site’s comparison tools. Once you start completing applications with prospective lenders, hard credit inquiries may cause your score to drop. However, completing several hard inquiries within a 15 to 45 day window to compare mortgage rates may not impact your score any more than a single inquiry.
In your search for the perfect lender, remember: they want your business. Because they want your business, it means they work for you, not the other way around. Don’t be shy about asking questions and trying to find terms that work best for your financial portfolio.
Some questions you should ask a potential lender include:
- How long (on average) does your approval process take?
- What type of lender fees do you charge, and how much are those fees?
- Do I have the option of rolling those fees into my loan, or will I have to come up with those funds in cash?
- Can you waive any of the fees?
- What are your down payment terms?
- Is this a fixed rate or adjustable rate offer?
- Are there any prepayment penalties?
Preparing for a loan application
If you think you are ready to take the next step in the loan application process, there are a few things you can do to help improve your odds of approval. When you take the time to do a little preparation, you’ll be more confident approaching the process. Plus, you can avoid potentially hurting your credit score by applying for a loan when you’re not quite ready.
Before you begin filling out the application, here are a few things you’ll need to do:
Know your goal: Why are you applying for a loan? You should have a tangible reason for taking this next step. Kapfidze recommends approaching the process from a long-term perspective — “Make a life decision, not just a financial decision.”
Check your credit report: You can access one free copy of your credit report from each of the credit bureaus once per year. Review your report to check for any errors or fraudulent charges. Lenders will see some of this information. It’s helpful for you to know what they’re going to see, so you can correct any issues if needed.
Reduce other debt: When possible, reduce other debt (especially credit cards) so that each account is at 30% or less of the max amount. Lenders want to see that you are a responsible borrower — plus, keeping your debt ratio low is great for your credit score. While you’re at it, make sure all your payments are on time. On-time payments give your score a boost and show lenders you are trustworthy.
Stop shopping: If you make big purchases right before or during the loan application process, a lender may delay or even deny your loan application. Put your spending (especially on credit cards) on hold until after your loan closes.
Understand the market: If you’re buying a home, knowing your market will prepare you for the type of loan process you might face. The process for a non-conforming loan can be more intense, so it’s best to know ahead of time if you’ll meet stricter requirements.
Get your paperwork in order: Lenders may ask to see two or more years of tax returns, several pay stubs, investment documentation, bank statements and other documents about any assets you own. Gather this information ahead of time to help speed up the process.
Taking out a loan, whether it’s a conforming loan or a non-conforming loan, can be an exciting time. Doing as much research and preparation as possible will make it easier for you to identify the terms and type of lender that is best able to meet your needs.