If you have ever applied for a mortgage, you may have heard lenders refer to loans and wonder what is the difference between conforming vs conventional loans?
But if you are a mortgage lender, you are fully aware that referring to a loan and know the differences between conforming vs conventional, knowing doesn’t always mean the same thing.
A lot of confusion around conforming mortgages stems from the fact that only conventional loans can be conforming loans. However, not all conventional loans (as you will soon see) are conforming mortgages.
So, what makes a loan a conventional loan and what makes it a conforming loan? Can a conventional loan be conforming?
Below we will discuss the differences between conforming vs conventional mortgage loans.
WHAT IS A CONFORMING LOAN? – CONFORMING VS CONVENTIONAL LOANS
Since the financial crisis of 2008, most consumers are familiar with the names Fannie Mae and Freddie Mac. These two quasi-government entities are mortgage aggregators that were placed into conservatorship under the oversight of the Federal Housing Finance Agency (FHFA)1.
Fannie Mae and Freddie Mac have deep roots within housing and financial markets and serve the purpose of purchasing mortgage loans, packaging them into mortgage-backed securities, and selling those loans to investors.
A conforming mortgage loan refers to a mortgage loan that meets Fannie Mae and/or Freddie Mac’s purchase requirements.
Most lenders sell most conforming mortgage loans to the secondary market. The sale usually happens a few months after the closing of the loan. Lenders may even take up to two months of escrows to cover this transition. Lenders choose to sell off these loans to increase liquidity, similar to that of a revolving line of credit.
However, just because a loan is sold doesn’t always mean the servicing of the loan necessarily changes. Lenders can receive income for administering and servicing the debt, often referred to as servicing rights.
An example of servicing responsibilities includes, but are not limited to, collecting monthly payments, maintaining escrows (where applicable), as well as providing information, notices, a copy of the note, and disclosures to the borrowers.
TYPES OF CONFORMING LOANS – CONFORMING VS CONVENTIONAL LOANS
Conforming loans are called conforming because they conform to Fannie Mae and Freddie Mac guidelines. Once a conventional loan has met this standard, then the conventional loan is now conforming. Not every conventional loan though is conforming, as these loans may not meet the Fannie Mae or Freddie Mac standard.
A conforming loan can be offered as either a fixed-rate or an adjustable-rate. Adjustable-rate mortgages are also referred to as variable-rate mortgages.
Fixed-rate mortgages inherently have an interest rate that is constant, meaning it doesn’t change over the life of the loan.
Adjustable-rate mortgages (ARMs) on the other hand may have an initial period where the rate is fixed, but after a certain point the repayment terms allow for the interest rate to adjust (either up or down, with certain periodic and lifetime caps) on a predetermined schedule. Please see your note for details, if applicable.
The increase or decrease is based on an index plus a set margin. Typical indices used are:
London Interbank Offer Rate (LIBOR)
11th District Cost of Funds (COFI)
Moving Treasury Average (MTA)
Fixed-rate mortgage loans are often advantageous for borrowers looking for a more stable or predictable monthly payment.
On the other hand, adjustable-rate mortgages can sometimes offer more favorable rates in the short term, benefiting those borrowers who are looking to pay off their mortgage within a specific time horizon.
Either option can be utilized for a purchase or refinance (both rate-term or cash out) transaction.
WHAT IS A NON-CONFORMING LOAN? – CONFORMING VS CONVENTIONAL LOANS
While conventional mortgage loans can certainly be conforming loans, they do not always meet the conforming criteria outlined by Fannie Mae and Freddie Mac. Thus, conventional mortgage loans can also be non-conforming mortgage loans.
The two main reasons why a mortgage loan may be considered non-conforming is that it can either be purchased by another entity or the loan does not fall within the standard conforming loan limits.
TYPES OF NON-CONFORMING LOANS
The two best examples of non-conforming mortgage loans are government-backed loans and jumbo mortgage loans.
As the name suggests, government-backed loans are loans that are insured by the federal government in some capacity.
In most cases, these loans are insured up to a certain threshold, protecting the lender in the event a borrower defaults on the debt. This lowers the risk of the lender who can then offer more favorable repayment terms to the borrower(s).
A few examples of government-backed mortgage loan programs are FHA, USDA, and VA loan programs. Many of these offer lower down payment requirements and more flexible underwriting criteria.
Jumbo mortgage loans are non-conforming mortgage loans that exceed the loan limit set by the FHFA, based on a variety of factors, that make them ineligible for purchase by Fannie Mae and Freddie Mac.
Since the jumbo mortgage loans usually carry higher loan amounts (as the name entails), they are often seen as carrying more risk compared to conforming counterparts. This usually means that certain lenders may require more rigorous credit standards and eligibility criteria.
Note that both government-backed and jumbo mortgage loans can both be offered as fixed-rate or adjustable-rate mortgages. However, because they do not meet the purchase criteria of either Fannie Mae or Freddie Mac, they wouldn’t be considered a conforming loan.
COMPARING CONFORMING VS NON-CONFORMING OPTIONS: PROS AND CONS
If you are in the market for a new mortgage loan figuring out whether to go with a conforming or non-conforming option can be a bit tricky.
Thankfully, New Century Mortgage has been able to help borrowers just like you weigh the pros and cons of multiple mortgage financing options, outline key benefits that align with your particular end-goals.
BENEFITS OF CONFORMING LOANS
Conforming mortgage loans certainly have some benefits over their non-conforming counterparts.
For starters, conforming mortgage loans have fairly standard qualification requirements. While Fannie Mae and Freddie Mac are two separate entities, their underwriting criteria and eligibility requirements align very closely.
While individual lenders may have additional underwriting overlays, in general most conforming loans require similar criteria for approval. This also simplifies the comparison process if borrowers want to shop lenders to find the best rate and repayment terms.
Additionally, conforming conventional loans are probably the most widely offered solution that consumers can take advantage of. This is partially due to the fact that these loans carry less risk, as they are being sold off into the secondary market as opposed to remaining on the lender’s books.
Since there are a multitude of lenders that offer conforming conventional mortgage loans, consumers have more choices on who they want to do business with.
Lastly, while it is not always the case, in general conforming mortgages can often offer a lower interest rate compared to other non-conforming options.
BENEFITS OF NON-CONFORMING LOANS
Non-conforming mortgage loans can be ideal programs for clients, some may even offer lower rates than conforming. The only difference is the loan programs simply don’t meet the requirements to be a conforming mortgage loan, another words these loans do not ‘conform’ to the standards set out by Fannie and Freddie.
In fact, there are several benefits to going with a non-conforming mortgage solution. In some cases that might be your only option.
Generally, government-backed non-conforming loans can offer lower down payment requirements compared to conforming conventional loans.
Some solutions may even waive a down payment altogether for borrowers who meet certain eligibility criteria. Most jumbo mortgage loan providers will still require a down payment.
However, jumbo mortgage loan options allow borrowers the flexibility of taking out a larger loan amount outside the conforming loan thresholds, assuming the applicant can carry the debt2. This can be beneficial for those transactions where the subject is a more expensive or unique piece of real estate.
Unlike conforming mortgage loans, non-conforming mortgage solutions are less restrictive with the types of real property being used as collateral. The same is true with respect to qualifying credit requirements, making non-conforming mortgage solutions much more individualized and flexible2.
The conforming loan limit
Every year, the dollar limit on what is deemed to be a conforming loan is updated by the FHFA. This includes limits for both Freddie Mac and Fannie Mac, which are the two government-sponsored enterprises that it regulates.
Freddie Mac and Fannie Mae buy mortgages that meet their criteria from lenders and then repackage them into mortgage-backed securities for investors. This process provides lenders with the liquidity that is required to keep presenting borrowers with affordable mortgage loans.
Both Freddie Mac and Fannie Mac have further criteria for the loans they buy, including maximum debt-to-income ratios (DTI), minimum down payments, and minimum credit scores. Yet, in general, when people speak about the standards for conforming loans, they are referring to loan limits.
So, what are these limits? For the year 2022, the conforming limit is $625,000 and what should be a high balance loan limit of $937,500. This is a fairly large jump from 2021, and almost $115,000 more than 2020. In 2021, the baseline conforming loan limit is $548,250. This is an increase from 2020. The year prior it was $510,400. The limit for 2020 could be bigger in areas where the median property cost exceeds this number, meaning borrowers in high-cost locations can get conforming loans of as much as $822,375, depending on the limit in the individual county.
Should you require a property loan that exceeds the conforming loan limit for your country, you are going to need to get a jumbo loan, which enables higher loan limits. Nevertheless, these loans tend to be more difficult for you to qualify for, requiring bigger down payments and higher credit scores.
What is needed for a Conventional Loan?
There are a number of different requirements when it comes to taking out a conventional loan, including the following:
If you are a first-time buyer, it is possible to get a conventional mortgage with a down payment that conforms to Fannie Mae and Freddie Mac’s guidelines. The requirement for a down payment will differ from person to person depending on such criteria as credit score, down payment, type of property, loan amount, if the property is primary, 2nd home or investment property and the sort of property or loan you are getting.
For instance, if you are making no more than 80 percent of the median income in your location, you might qualify for Home Ready or Home Possible. There are other mortgage programs that could require a set minimum or even no down payment requirement such as VA and USDA. However, you will still need enough money for closing costs and possibly other expenditures.
If the property you are purchasing is not a single-family home, i.e. it has more than one unit or if it is a second home or investment property you may need to have a larger down payment depending on the program.
Jumbo loans up to $3,000,000 might be accessible through top lenders, however the larger the loan amount, the harder it may prove to qualify. Loans above $3,000,000 may require more documentation and reserves depending on the scenario. A larger loan amount may require a larger down payment as well, so please make sure to inquire to see what documentation might be needed and other items to properly set your expectations.
Private mortgage insurance
You might also need to pay for private mortgage insurance (PMI) if you put down less than 20 percent on a conventional loan.
Private mortgage insurance protects your lender if a circumstance arises whereby you default on your loan.
How much PMI costs could depend on various factors such as the type of loan you take out, your credit score, the size of your down payment and your loan size.
You might pay for PMI as part of your monthly mortgage payment, but there are some other ways to cover the expense as well. For example, if the lender allows it depending on the mortgage program, some buyers opt to fund it as an upfront payment, whereas others pay it in the form of a slightly larger interest rate.
Some important terms you need to understand
There are a few important terms that you need to understand when it comes to confirming and non-conforming loans. So, let’s take a look.
Index is an economic indicator that is utilized for the purpose of calculating interest rate adjustments for ARM loans. The index rate can decrease or increase at any time. The index most commonly used at the time of writing is the Constant Maturity for loans with the backing of the United States government, previously it was the London Interbank Offered Rate (LIBOR) for conventional loans.
Cap structure is a numerical representation of every cap for the loan. This is presented in a series of three numbers that represent the three caps: lifetime cap, periodic cap, and initial cap.
Margin refers to the percentage point that your lender has predetermined. This remains the same throughout the entire life of the loan. It is used to figure out the interest rate for loans. Once the initial fixed-rate term concludes on an ARM, the interest rate will typically adjust yearly, and this new rate is determined by adding the index to the margin. Although this can result in the interest rate getting bigger, there are no caps on how much it can increase.
1. HISTORY OF FANNIE MAE & FREDDIE MAC CONSERVATORSHIPS. (n.d.). Retrieved July 21, 2020, from https://www.fhfa.gov/Conservatorship/Pages/History-of-Fannie-Mae–Freddie-Conservatorships.aspx#:~:text= Long-term, continued operation in,Fannie Mae or Freddie Mac.&text=Until Congress determines the future, out its responsibilities as Conservator.
2. Non-Conforming Loan (n.d.). Retrieved July 21, 2020, from https://www.zillow.com/mortgage-learning/glossary/non-conforming-mortgage-definition/