What Is A Conforming Loan And How Does It Work?

As you shop around for a mortgage, it’s important that you’re aware of the types of loans that are available to you. However, understanding all that mortgage industry lingo can feel overwhelming.

Don’t sweat the jargon. Let’s go over – in simple terms – what exactly a conforming loan is, when you might get one and what the conforming loan limits are for 2022.

What Is A Conforming Mortgage?

A conforming mortgage loan – sometimes referred to as a conventional mortgage –  is one of the types of home loans you’ll encounter when you begin shopping for a mortgage.

Here’s a quick overview.  A conforming loan is any mortgage that meets the standards for purchase and sale by the government-sponsored enterprises Fannie Mae and Freddie Mac.

The Federal Housing Finance Agency (FHFA) issues the rules that qualified loans must conform to. Conforming loan requirements have to do with how much you can borrow, the types of properties you can purchase and whether you have the ability to repay the loan. Additionally, to qualify, lenders must make disclosures throughout the loan process to keep borrowers informed about their costs.

How Do Conforming Loans Work?

When you buy a house, you might think your mortgage stays with your lender, who waits patiently until you finish paying it back. But that’s not the case. For most conventional loans, borrowing guidelines are made by the GSEs. The GSEs, Fannie Mae and Freddie Mac, buy loans from lenders that meet their guidelines. This gives lenders a constant flow of money so lenders can continue lending.

What does Fannie or Freddie do with your mortgage? Essentially, they bundle your mortgage with other similar mortgages, based on factors including loan amount and credit score. Next, they securitize the mortgages and sell these securities called mortgage-backed securities (MBS) on the secondary mortgage market. The investors who buy agency MBS sold by Fannie Mae or Freddie Mac are looking for low-risk income, often to finance their retirement.

Fannie and Freddie don’t directly make loans. Instead, the private sector is incentivized to meet their consumer protection requirements because they know the GSEs have specified criteria for the types of loans they’ll buy because they’re taking on the risk by purchasing the mortgage. They won’t buy any loans that don’t meet their requirements.

How The Rules Work

The law doesn’t mandate these rules for all lenders and loans. Rather, it incentivizes lenders who operate by making loans and then selling them to Fannie and Freddie to continue this practice by conforming to their requirements.

These requirements have to do with how much you can borrow, the types of properties you can purchase and whether you have the ability to repay the loan. Mortgage loan guidelines – such as having a minimum credit score or maximum debt-to-income ratio (DTI) as a prerequisite for loan approval – exist to prevent lenders from lending money to borrowers who can’t afford their loan payments. They help protect a borrower from taking on more debt than they can manage. They also protect the lender from taking on too much risk.

Conforming Loans Vs. Non-Conforming Loans

A conventional loan that doesn’t meet the criteria to be purchased by Fannie Mae or Freddie Mac is known as a non-conforming loan. A common type of non-conforming loan is a jumbo loan. Jumbo loans are loans that exceed the conforming loan limit. Typically, the interest rate and required down payment is higher on a non-conforming loan. The borrower eligibility guidelines for non-conforming loans vary across lenders.

Rocket Mortgage^® offers the Jumbo Smart loan, which is a home loan up to $3 million for 30-year fixed loans and up to $2.5 million for 15-year fixed and 7-year adjustable rate mortgages (ARMs.) Down payment and credit score requirements will vary depending on loan terms, how much you plan to borrow and the size of your down payment. Significantly, there is no private mortgage insurance (PMI) required.

The other most common types of nonconforming loans are government-insured loans through the Federal Housing Administration (FHA), Veterans Administration (VA) and the U.S. Department of Agriculture.

Other types of non-conforming loans are geared toward borrowers who don’t meet conforming loans standards. In many cases, self-employed or seasonal workers have a hard time providing adequate verification of their income and must rely on a non-conforming loan to purchase a home. Loans geared toward borrowers with past negative credit items may come with higher interest rates.

Conforming Vs. Conventional

There’s often confusion about this, but it’s important to note that a conforming loan is the same as a conventional loan. These are loans that are purchased by Fannie Mae and Freddie Mac. Because both of these enterprises are currently under federal conservatorship, there’s also an implied government guarantee. This allows the everyday consumer a chance at more affordable homeownership. On the flip side, the government doesn’t have any reason to subsidize high-income earners who want to borrow above-average sums to purchase showcase homes. Hence the conforming loan limits that lenders must comply with. 

What’s the difference between the GSEs? Essentially, Fannie Mae buys mortgages from large commercial banks while Freddie buys mortgages from smaller savings-and-loans, credit unions and regional banks. You can find out who owns your current mortgage by using Fannie’s look-up tool or Freddie’s counterpart.

What Are Conforming Loan Limits?

Basically, a conforming loan is a home loan whose amount doesn’t exceed a certain dollar amount. That dollar amount is determined each year by the FHFA. The national conforming loan limit for 2022 is $726,200. However, in many high-cost areas, there is simply no housing to be had at the upper limit. In these high-cost areas, the limit is $1,089,300.

For a conventional loan to be considered a conforming loan, the loan amount must be lower than the limit set by the FHFA.

How Do Conforming Loan Limits Work?

What does this mean in practice? Say you want to buy a one-unit home in Wayne County, Michigan, for $250,000, and you use a conventional loan of $200,000 to do so. Because your loan is well under the loan limit of $647,200, your mortgage will be considered a conforming loan.

On the other hand, if you want to buy the same single-family home in San Francisco, you’d likely need to plan on spending at least $1.5 million. A 20% down payment would equal $300,000, meaning you’d need a $1.2 million loan.

You have two choices for financing this home purchase. Let’s take a look at them.

Increase The Down Payment To Qualify For A Conforming Loan

First, use the FHFA’s interactive map tool to determine the conforming loan limit for San Francisco, which is located in Marin County, CA. The map shows that it qualifies for the maximum loan amount of $970,800.

However, after your planned down payment of $300,000, you’d still need to borrow $1.2 million, which exceeds the maximum loan amount by $229,200. In other words, if you wanted to enjoy the lower rates offered with conforming loans, you’d have to increase your down payment of $300,000 by $229,200 for a total down payment of $529,200.

$1.2 million ﹣$970,800 = $229,200

$300,000 (original intended down payment) + $229,200 + $970,800 = $1.5 million

Apply For A Jumbo Loan

You could alternatively apply for a non-conforming jumbo loan. If you do this, you'll face qualification requirements that are more strict based on the higher loan amount. As a result, you’ll need to choose your lender even more carefully.

For your San Francisco home purchase, Rocket Mortgage’s Jumbo Smart loan would meet your needs without forcing you to put down more money than you’d originally planned. We would require a 10.01%, or $150,150, for a down payment. You wouldn’t pay for PMI, which typically costs between 0.1 and 2% of the loan amount annually. On a $1.2 million loan, this alone could save you anywhere between $500 and $1,000 per month.

Other Criteria For A Conforming Loan

Though loan size is a big part of determining what is and isn’t a conforming loan, there are other guidelines Fannie Mae and Freddie Mac have for the loans that they buy.

Single-Family Home

While many of us may think of a single-family home as being a home in which only one family lives, the FHFA does not. It defines a single-family home as any home with 1 – 4 units.

Ability To Repay

These guidelines include limits on acceptable credit scores, debt-to-income ratios (DTI) and loan-to-value ratios (LTV).

To qualify for a conforming loan, you’ll generally need a credit score of at least 620, a DTI below 50% and a maximum LTV of 97% (meaning you’ll need to put at least 3% down).

All these factors impact, your interest rate so the exact rate you get will depend on your individual application. For example, if your credit score is on the lower end of the range of what qualifies, you might have a higher rate than someone with the same down payment but a better credit score.

Additionally, depending on your financial profile, you may need to have a few months’ worth of reserves, which is cash you’ve saved up that could be used to cover your mortgage payments if you were to experience financial hardship.

Keep in mind that while Fannie Mae and Freddie Mac have minimum requirements for the types of loans they consider to be conforming, lenders can also have their own, more stringent requirements on top of the conforming loan criteria.

Disclosure

Certain disclosures applying to all mortgage loans including conforming loans will be made to borrowers as they proceed through the mortgage application process. Sometimes referred to as “TILA-RESPA” (Truth in Lending Act and Real Estate Settlement Procedures Act of 1974) or TRID disclosures (TILA-RESPA Integrated Disclosures), these are required disclosures that lenders must make to home loan applicants.

The Consumer Financial Protection Bureau requires disclosures of estimated loan costs after preapproval and a Closing Disclosure 3 days prior to closing day as part of its Know Before You Owe initiative.

Benefits Of Conforming Loans

Having a loan that conforms with guidelines set by Fannie Mae and Freddie Mac has important advantages.

Lower Interest Rates

Conforming loans typically offer lower interest rates to borrowers with high credit scores, making them a great option if your goal is to get a low monthly payment. Offers accompanied by a conventional loan preapproval letter tend to be more popular among sellers because FHA appraisals are considered more cumbersome than standard appraisals.

Ability To Shop Around

Conforming loans are offered by many different lenders, giving you the opportunity to compare services and prices. Moreover, because of the required disclosures, you’ll have a complete breakdown of a lender’s estimated costs shortly after preapproval, which makes it easier to compare multiple preapproval offers.

Consumer Protection Guidelines

Conforming loans have standardized guidelines and forms meant to protect the borrower and lender from poor lending practices. Lenders can no longer offer mortgages without proper verification of income, assets and credit history, and they can’t make loans to borrowers who have no way to repay them.

Mortgage Insurance Removal

If you make a down payment of more than 20%, you don’t have to pay for mortgage insurance at all on a conventional loan. If you do end up paying for mortgage insurance, you can request removal you reach 20% equity if it’s based solely on the payments being made and not the home improvements. If home improvements or value increases are involved, it gets more complex. Speak with a Home Loan Expert.

Occupancy Flexibility

Conventional loans are the only ones you can use to buy a vacation home. Additionally, conforming loans are the only ones you can use to buy a non-owner-occupied residential investment property.

Down payments and interest rates are slightly higher for second homes and rental properties, but it’s an option.

The Bottom Line: Conforming Loans Offer Lower Interest And Greater Consumer Protections

Conforming loans are typically preferred by those seeking to avoid paying a high interest rate, and represent the largest sector of home loans. Want to learn more about how to shop around for the best mortgage? Our Learning Center has all the information you need as you move through the home buying process.. If you’re interested in going over your options, you can apply online or give us a call at (888) 452-0335.