What is a conforming loan? The name offers a clue. According to Merriam-Webster, conformation can refer to (1) the structure of an object or arrangement, (2) how pieces and parts come together to form a whole, or (3) how well something matches the expected model. When you’re talking about conforming loans, the third definition is most relevant.
What Is a Conforming Loan?
What is a conforming loan? As Credit Karma reports, the short answer is that a conforming loan is a conventional loan that conforms to guidelines set by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. Better known as Fannie Mae and Freddie Mac, these two government-controlled entities work to support homeownership by adding liquidity to the secondary mortgage market through the purchase of mortgages from lenders. Basically, these organizations buy home loans from lenders, providing them with the money to make new loans for borrowers.
To better understand conforming loans, it helps to learn a little about conventional loans.
As The Mortgage Reports explains, a conventional loan is a home loan that is not backed or guaranteed by the government. Without a government guarantee to offset the damage from any losses, a conventional loan is a riskier prospect for a lender. As a result, these loans typically come with higher interest rates and stricter credit standards. However, when fees and insurance programs are taken into account, conventional loans can ultimately be more affordable than comparable government-backed loans for qualified borrowers.
Conventional loans are either conforming or nonconforming.
Which conventional loans are conforming loans? The defining factor is their size. The loan amount must be at or below the conforming loan limit, which is set every year by the Federal Housing Finance Agency. According to Investopedia, the conforming loan limit for one-unit properties is $510,400 in 2020. In high-cost areas like New York City and Southern California, the limit rises to $765,600.
The size of the loan is important, but it’s not the only thing that matters. Lenders must also check that borrowers meet certain requirements when issuing conforming loans. According to Credit Karma, borrowers must have a credit score between 620 and 700. Their debt-to-income ratio must be less than 45 percent, and they may need to have a minimum cash reserve on hand. Finally, they will need to have private mortgage insurance if they make a down payment of less than 20 percent.
A conventional loan that doesn’t meet the standards of a conforming loan is called a nonconforming loan. If the loan exceeds the conforming loan limits, it’s often referred to as a jumbo loan. However, as NerdWallet points out, size isn’t the only quality that can make a loan a fit into the nonconforming category. Even small loans can be nonconforming loans if they are extended to borrowers who don’t meet the guidelines set by Freddie Mac and Fannie Mae.
The Advantages of Conforming Loans
Why might a borrower opt for a conforming loan? Lenders appreciate the flexibility that comes with being able to sell these loans, so they’re often more willing to work with them than nonconforming loans. As Investopedia reports, this means that qualified borrowers can find attractive home loans with competitive interest rates and down payment requirements as low as 3 percent. Plus, conforming loans often offer greater flexibility in terms of the property that they can be used to purchase.
Whether you’re interested in a conforming loan, a nonconforming loan, a government-backed loan, or a refinancing option, the team of friendly loan professionals at PrimeLending Twin Cities can help. We understand that everyone’s idea of the perfect home is different, so we don’t offer one-size-fits-all solutions. Instead, we take the time to discuss your housing goals. We’ll help you explore the possibilities and guide you through the approval process. To learn more about our services, contact us today.