Conforming vs conventional loans

If you’ve ever applied for a mortgage, you might have heard terms like “conforming” and “conventional” and wondered what they mean. While these terms are often used interchangeably, they have distinct meanings in the mortgage world. Here’s a breakdown to help clarify the difference between conforming and conventional loans.

Since the 2008 financial crisis, most people are familiar with Fannie Mae and Freddie Mac, two government-sponsored enterprises (GSEs) that play a significant role in the mortgage market. These organizations buy mortgages, bundle them into securities, and sell them to investors. They set specific guidelines for the mortgages they purchase.

A conforming loan is one that meets the guidelines set by Fannie Mae and Freddie Mac. Most lenders sell conforming loans to the secondary market shortly after closing, usually within a few months, to increase liquidity. This practice helps lenders free up funds to make more loans. However, the servicing of the loan—such as collecting payments and managing escrow accounts—may remain with the original lender.

Conforming loans adhere to the standards set by Fannie Mae and Freddie Mac and can be either fixed-rate or adjustable-rate:

• Fixed-Rate Mortgages: These have an interest rate that remains constant throughout the life of the loan, providing predictable monthly paym
• Adjustable-Rate Mortgages (ARMs): These have an initial fixed-rate period, after which the interest rate adjusts periodically based on an index plus a margin. Common indices include the Secured Overnight Financing Rate (SOFR) and previously, the London Interbank Offered Rate (LIBOR). ARMs can offer lower initial rates but come with the risk of higher payments later.

Non-conforming loans do not meet the criteria set by Fannie Mae and Freddie Mac, making them ineligible for purchase by these GSEs. There are two main reasons a loan might be considered non-conforming:

• It exceeds the conforming loan limits: These limits are set annually by the Federal Housing Finance Agency (FHFA) and can vary by location.
• It’s not eligible for purchase by Fannie Mae or Freddie Mac: This can include loans that do not meet the specific underwriting criteria.

The most common non-conforming loans are:

• Government-Backed Loans: These include FHA, USDA, and VA loans, which are insured by the federal government. They often offer lower down payment requirements and more flexible underwriting criteria.
• Jumbo Loans: These exceed the conforming loan limits set by the FHFA and are not eligible for purchase by Fannie Mae or Freddie Mac. Jumbo loans generally carry higher interest rates and stricter credit standards due to their larger size and higher risk.

Both government-backed and jumbo loans can be fixed-rate or adjustable-rate, but because they don’t meet the purchase criteria of Fannie Mae or Freddie Mac, they are not considered conforming.

When deciding between conforming and non-conforming loans, consider the following benefits and drawbacks:

Benefits of Conforming Loans:

• Standardized Qualifications: Conforming loans have consistent underwriting requirements, making it easier to compare offers from different lenders.
• Wide Availability: Conforming loans are widely offered by lenders, giving borrowers more options to choose from.
• Lower Interest Rates: Generally, conforming loans may offer lower interest rates compared to non-conforming options, due to their lower risk profile and the fact that they are sold to the secondary market.

• Higher Interest Rates: Non-conforming loans, such as jumbo loans, often come with higher interest rates due to their increased risk.
• Stricter Eligibility: Government-backed loans may have specific eligibility requirements, while jumbo loans may require higher credit scores and larger down payments.

For personalized advice and to explore your mortgage options, consider consulting with a mortgage professional who can help you navigate the benefits and challenges of both conforming and non-conforming loans.

Non-conforming loans can be an attractive option for some borrowers, potentially offering lower rates than conforming loans. The key distinction is that these loans do not meet the specific criteria set by Fannie Mae and Freddie Mac, which makes them non-conforming by definition.

Here are some advantages of non-conforming loans:

• Lower Down Payment Options: Government-backed non-conforming loans often have more lenient down payment requirements compared to conforming conventional loans. In some cases, these programs may even eliminate the need for a down payment altogether for eligible borrowers. Jumbo loans, however, generally require a down payment but provide the flexibility to finance larger amounts beyond conforming limits.
• Greater Loan Amounts: Jumbo mortgages allow for borrowing larger sums that exceed the conforming loan limits. This is beneficial for purchasing high-value or unique properties where standard loan amounts are insufficient.
• Flexibility in Property Types: Non-conforming loans are less restrictive regarding the types of real estate that can be used as collateral. They also offer more individualized credit requirements, making them a flexible option for diverse borrowing needs.

When applying for a conventional loan, there are several key requirements to be aware of:

• Down Payment: The amount needed for a down payment varies based on factors like credit score, property type, loan amount, and whether the property is a primary residence, second home, or investment property. Programs such as HomeReady or Home Possible may offer lower down payment options for eligible borrowers. For government-backed loans like VA or USDA, down payment requirements may be minimal or waived. However, closing costs and other fees will still apply.
• Loan Amount: Conventional loans can reach up to $3,000,000 through leading lenders, though qualifying for larger amounts may require more documentation and reserves. Higher loan amounts often necessitate larger down payments, so it’s essential to understand the documentation requirements and adjust your expectations accordingly.

Selecting the right mortgage involves evaluating both conforming and conventional loans. Here’s a breakdown of their pros and cons:

• Competitive Interest Rates: Conforming loans generally offer lower interest rates due to the backing of Fannie Mae and Freddie Mac.
• Flexible Credit Requirements: They can accommodate borrowers with slightly lower credit scores, which is beneficial for first-time homebuyers.
• Standard Qualification: Qualification criteria are consistent across lenders, simplifying the comparison process.

• Loan Limits: Conforming loans have maximum limits that vary by location, which may not be sufficient for more expensive homes.
• Down Payment Requirements: Some conforming loans require a down payment, which can be a significant upfront cost.

• Higher Loan Limits: Conventional loans often allow for larger loan amounts, which is advantageous for purchasing high-value properties.
• Down Payment Flexibility: They offer varied down payment options, potentially reducing the initial cash requirement.
• No Mortgage Insurance: Borrowers can avoid mortgage insurance costs if they meet specific requirements.

• Stricter Requirements: Conventional loans may demand higher credit scores and larger down payments compared to conforming loans.
• Potentially Higher Interest Rates: Since they are not government-backed, conventional loans may have higher interest rates.

When choosing between conforming and conventional loans, consider these factors:

• Interest Rates: Compare rates from various lenders to ensure you get the best deal.
• Credit Score: Assess your credit score to determine which loan option you qualify for.
• Down Payment: Evaluate your financial situation to decide which down payment option suits you best.
• Loan Limits: Consider if the loan limits align with your home purchasing needs.
• Mortgage Insurance: Understand the implications of mortgage insurance for both loan types.

By weighing these considerations and working with a knowledgeable lender, you can make a well-informed decision and find the mortgage option that best fits your financial goals and needs.