If you're ready to buy anything from a starter home to your dream home, a conforming loan offers significant advantages for both borrowers and lenders. While you might need to meet additional criteria to qualify for a conforming loan, you could save significantly on interest rates and fees. Read on to understand how conforming loans work, whether you can qualify and to understand this mortgage option's pros and cons.
What Is a Conforming Loan?
A conforming loan or conforming mortgage is a loan product that meets Fannie Mae and Freddie Mac guidelines. Lenders who work with Fannie Mae and Freddie Mac guidelines can underwrite and fund the loans before selling them. After Fannie Mae or Freddie Mac buys the mortgages from lenders, the loans are sold to investors on open markets. In this way, conforming loans help support liquidity in the mortgage markets.
Conforming loans typically have lower interest rates and fees than nonconforming loans because of their liquidity and government control. For borrowers, this can lead to significant savings. Conforming loans allow lenders to get the loans off the books and free up liquid capital to offer additional mortgages.
How Do Conforming Loans Work?
When you start researching mortgages, you'll come across different loan types, including conforming and nonconforming mortgages and mortgages backed by government agencies like the Federal Housing Administration (FHA), Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA). Conforming mortgages must meet certain government guidelines. For example, you'll need a minimum credit score of 620 to qualify for a conforming loan.
Conforming loans have dollar cap limits set by the Federal Housing Finance Agency (FHFA) on mortgages that Freddie Mac and Fannie Mae are willing to buy or guarantee. For 2024, the conforming loan limit is $766,550. If you need a larger mortgage, you'll need a nonconforming loan.
Freddie Mac and Fannie Mae are government-sponsored entities designed to drive the market for home loans. These agencies have standardized rules and guidelines that single-family dwellings must conform to to be eligible for backing.
Fannie Mae and Freddie Mac don't issue mortgages. Instead, they insure mortgages issued by lenders, such as banks, and act as secondary market makers when lenders want to sell those mortgages.
Conforming loans have stricter guidelines than nonconforming loans, ultimately benefiting both the lender and the borrower. As a borrower, you’ll save more money over the life of the loan with lower fees and less mortgage insurance. You'll also know that the lender is confident in your ability to repay the loan you qualified for. Lenders gain the benefit of liquidity and greater security from conforming loans.
Conforming Loans vs. Nonconforming Loans
The difference between conforming loans and nonconforming loans is in specific guidelines. While conforming mortgages meet Fannie Mae and Freddie Mac guidelines, nonconforming mortgages do not. For example, jumbo loans are a type of nonconforming loan that exceeds Fannie Mae and Freddie Mac limits. If you can qualify for a conforming loan, you'll generally get better terms and pay less in both interest and fees.
Conforming Loans vs. Conventional Loans
A conventional loan is any loan not guaranteed or insured by the government. FHA, VA and USDA loans are government-backed, which means they aren't conventional. Other mortgages are usually conventional loans.
A conventional loan can be either conforming or nonconforming. A conforming loan meets specific criteria the FHFA sets, including conforming loan limits. That means you could have a conventional conforming or nonconforming loan.
In summary:
- A mortgage is a conventional loan if it's not government-backed.
- A mortgage is conforming if it meets Fannie Mae or Freddie Mac guidelines.
- Conventional mortgages can be either conforming or nonconforming.
Conforming Loan Limits and Rules
The FHFA sets limits each year and designates limits by county. You can’t borrow more than the limit for the year, although some high-cost areas have higher limits. For 2024, the conforming loan limit is $766,550.
There are exceptions. The maximum loan limit for areas where 115% of the local median home value exceeds the baseline conforming loan limit will be higher. A ceiling limit is set at 150% of the baseline loan limit.
Areas with higher loan limits include Southern California, the New York metropolitan area and South Florida. The highest-cost areas are Alaska, Hawaii, Guam and the U.S. Virgin Islands, where the 2024 ceiling loan limit is 150% or $1.15 million for single-family properties or up to $2.2 million for four-unit properties.
In addition, to qualify for a conforming loan, you'll need a down payment of at least 3% or more of the loan value. With 20% down, you can avoid paying private mortgage insurance. You'll also need a debt-to-income ratio (DTI) of 45% or less, although you could qualify with a DTI ratio up to 50% if you have a higher credit score or a larger down payment.
Advantages and Disadvantages of Conforming Mortgages
While there are significant advantages to conforming mortgages for buyers and lenders, they have a few disadvantages. Here's what you want to consider.
Pros
- Avoid mortgage insurance: With a conforming loan, you aren't required to take private mortgage insurance if you make a 20% downpayment.
- Low down payment: You can qualify for a conforming mortgage with a down payment as low as 3%.
- Flexible loan terms and borrowing limits: Many mortgage lenders offer conforming mortgages, allowing you to shop around and find a lender with the most favorable terms. You can also get higher borrowing limits in high-cost areas.
- Lower annual percentage rates (APRs): Conforming loans often have lower interest rates (APR) than nonconforming loans. This means you could save significantly over the life of the loan.
Cons
- Limits on debts: You'll need to meet conforming loan DTI ratio limits, which can be as low as 36% or as high as 50% if you have other factors in your favor, like a larger down payment and a high credit score.
- Higher interest rates: A conforming loan doesn't guarantee a favorable interest rate. You'll still need to shop around to secure the best options.
- Credit score requirement: You'll need a credit score of at least 620. If you have a lower credit score, you'll need to work to improve your credit score before applying for a conforming loan.
- Borrowing limits: Borrowing limits mean you might not be able to use a conforming loan to buy your dream home, especially in high-priced markets.
How to Apply for a Conforming Loan
If you're ready to apply for a conforming loan, the process is similar to nonconforming or government-backed mortgages. Here are the steps to take.
Meet the Minimum Requirements
The minimum borrower requirements to qualify for a conforming loan include:
- Credit score of at least 620
- Debt-to-income ratio (DTI) of 36%, or up to 50% if you have other positive factors like a high credit score or downpayment
- At least a 3% down payment for a home purchase or 5% equity for a refinance
Gather All Necessary Financial Documents
You must be prepared with pay stubs, tax returns, bank statements and other required financial statements.
Research and Compare Lenders
After determining your budget, you can get a preapproval mortgage to get a clear idea of how much you can afford. You can compare interest rates and total fees to find the most favorable options. Start by comparing the best online mortgage lenders and speaking with your local bank or credit union. Remember to shop around and compare offers to get the best options. Learn how to get FHA loan preapproval or the difference between preapproval and prequalification.
Complete a Loan Application With Your Chosen Lender
After completing the preapproval process and finding a home, it's time to complete the final mortgage application with the lender and prepare to purchase the property.
Work With the Lender to Complete the Underwriting Process
The underwriting process could be done in as little as a week but can take up to six weeks to finalize. You should stay in close contact with the lender throughout the underwriting process to supply any additional information requested.
Review and Sign the Loan Documents Once Approved
Once you have final mortgage approval, it's time to carefully review the loan repayment terms, including early repayment penalties, interest rates, private mortgage insurance requirements and fees. Once you're confident that everything is correct, it's time to sign and secure your conforming mortgage.
Should You Use a Conforming Mortgage?
Conforming mortgages offer significant advantages for both lenders and borrowers. Conforming mortgages could save you significantly on interest and fees over the loan's lifetime if you meet qualification requirements. Ready to get started? Find some of the best conventional mortgage lenders here.
Frequently Asked Questions
What types of properties can be financed with a conforming loan?
Both commercial and residential properties can be financed with conforming loans.
Can I use a conforming loan to refinance my existing mortgage?
Yes, if you meet qualification requirements, you can refinance and pay off your existing mortgage with a new conforming loan.
Are conforming loan interest rates fixed or adjustable?
Conforming loan interest rates can be either fixed or adjustable.
About Alison Plaut
Alison Plaut is a personal finance and investing writer with a sustainable MBA, passionate about helping people learn more about wealth building and responsible debt for financial freedom. She has more than 17 years of writing experience, focused on real estate and mortgages, business, personal finance, and investing. Her work has been published in The Motley Fool, MoneyLion, and she regularly contributes to Benzinga.