Conforming

If you’ve ever applied for a mortgage, you might have heard the terms “conforming” and “conventional” loans and wondered what distinguishes them. While mortgage professionals are familiar with these terms, understanding their differences can still be confusing.

Many people are unaware that while all conforming loans are conventional, not all conventional loans qualify as conforming. So, what makes a loan conventional and what makes it conforming? Can a conventional loan be conforming?

Here’s a breakdown of the differences between conforming and conventional mortgages:

Since the 2008 financial crisis, most people are familiar with Fannie Mae and Freddie Mac, two government-sponsored enterprises (GSEs) that play a crucial role in the mortgage market. These entities purchase mortgages, package them into mortgage-backed securities, and sell them to investors, which helps to provide liquidity in the housing market.

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, typically within a few months. The sale of these loans helps lenders maintain liquidity, similar to how a revolving line of credit works.

However, selling a loan does not necessarily change its servicing. Lenders may continue to service the loan, which includes collecting payments, managing escrows, and handling customer service tasks.

Conforming loans adhere to the guidelines set by Fannie Mae and Freddie Mac. Once a conventional loan meets these guidelines, it is considered conforming. Not all conventional loans qualify as conforming, as they might not meet Fannie Mae or Freddie Mac’s standards.

Conforming loans can be either fixed-rate or adjustable-rate. Fixed-rate mortgages have an interest rate that remains constant throughout the loan term. Adjustable-rate mortgages (ARMs) may have an initial fixed period, after which the interest rate can fluctuate based on an index and a margin, subject to periodic and lifetime caps. The Secured Overnight Financing Rate (SOFR) is the current index used for ARMs, replacing previous indices like LIBOR and COFI.

Non-conforming loans do not meet Fannie Mae and Freddie Mac’s criteria and are therefore not eligible for purchase by these entities. Conventional loans can be non-conforming if they are either not purchased by Fannie Mae or Freddie Mac or exceed the conforming loan limits.

Government-Backed Loans: These include FHA, USDA, and VA loans, which are insured by federal agencies. These loans often offer lower down payment requirements and more flexible underwriting criteria, making them accessible to a broader range of borrowers.

Jumbo Loans: Jumbo loans exceed the loan limits set by Fannie Mae and Freddie Mac and are not eligible for purchase by these entities. Due to their larger size, jumbo loans often carry higher risks, which may lead to more stringent credit requirements and down payments.

Benefits of Conforming Loans:

• Standardized Qualification: Conforming loans have well-defined qualification criteria set by Fannie Mae and Freddie Mac, making them easier to compare across lenders.
• Widely Available: Due to their lower risk, conforming loans are widely offered, providing borrowers with numerous options.
• Potentially Lower Interest Rates: Conforming loans often have lower interest rates compared to non-conforming options, leading to savings over the life of the loan.

Benefits of Non-Conforming Loans:

• Higher Loan Limits: Non-conforming loans, such as jumbo loans, allow for larger loan amounts, which is beneficial for high-cost areas.
• Flexibility in Down Payments: Government-backed loans may offer lower or even zero down payment options for qualified borrowers.
• Less Restrictive Property Requirements: Non-conforming loans may have fewer restrictions on property types and borrower qualifications.

Conventional loans come with various requirements, including:

• Down Payment: This varies based on factors such as credit score, property type, and loan amount. Some programs, like HomeReady or Home Possible, offer lower down payment options, while jumbo loans might require larger down payments.
• Credit Score: Higher credit scores generally qualify for better terms, but specific requirements can vary by lender and loan type.

Choosing between conforming and conventional loans requires careful consideration of factors such as interest rates, credit requirements, and down payment needs. Conforming loans typically offer lower rates and standard qualification criteria, while conventional loans provide more flexibility in loan amounts and property types but may come with higher rates and stricter requirements.

To make the best decision, evaluate your financial situation, compare offers from different lenders, and consider consulting with a knowledgeable mortgage professional to find the loan that best fits your needs.