What Is a Conforming Loan?

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DEFINITION

A conforming loan is a mortgage that meets the terms set by the Federal Housing Finance Agency (FHFA), Fannie Mae, and Freddie Mac.

What Is a Conforming Loan?

A conforming loan is a home loan that falls within the loan size limits set by the FHFA. It adheres to other rules established by Fannie Mae and Freddie Mac, two government-sponsored companies that are regulated by the FHFA. A loan that meets these conditions allows Fannie Mae and Freddie Mac to buy your mortgage from your lender and convert it into an investment product.

How a Conforming Loan Works

Fannie Mae and Freddie Mac buy mortgages on the secondary market to meet the FHFA's goals of liquidity, affordability, and stability in the mortgage market. They then either package them into securities or they hold them in a portfolio.

But Fannie Mae and Freddie Mac are restricted by law to buying conforming loans that are no larger than the limits set by the FHFA. These limits, known as the conforming loan limits, vary by year and location. Conforming loans also have other underwriting criteria. Fannie Mae has rules for lenders that take into account loan-to-value ratio, debt-to-income ratio, and credit score.

Let's say that a lender wants to get mortgages off its own balance sheet. It knows that Fannie Mae or Freddie Mac will potentially buy the loan later if it makes a loan that meets the guidelines set forth by the FHFA. The lender therefore creates a conforming loan. You, as a qualifying buyer looking to finance a home, obtain the loan.

The lender will eventually sell your mortgage to Fannie Mae, freeing up more capital to make more loans in order to keep the mortgage market affordable and stable. As the borrower, you'll usually get a loan ownership transfer notice indicating that your mortgage was sold.

Call the mortgage servicer listed on your mortgage statement or send them a written request to find out who owns your mortgage because this can change over time. You can also use the "Fannie Mae Mortgage Lookup Tool" and Freddie Mac's "Loan Lookup Tool" to confirm whether your mortgage is owned by one of these companies.

How Much Can I Borrow in Conforming Loans?

The FHFA has announced an increase in the maximum conforming loan limit for loans to be acquired by Fannie Mae and Freddie Mac. The limit is $647,200 in 2022, up from $548,250 for 2021.

The FHFA offers a complete list of conforming loan limits by county in the United States if you want to know what to expect from your own local area. Limits vary by the number of units within a dwelling, ranging from one to four.

The Housing and Economic Recovery Act (HERA) requires that the conforming loan limit be adjusted each year to reflect changes in the average price of homes in the U.S. The conforming loan limit rises as prices rise, so housing remains attainable for middle- and lower-income buyers.

High-cost areas offer “conforming jumbo” loans that are still part of the conforming program but have higher loan limits for one-unit properties of up to 150% of the baseline. The maximum loan amount for 2022 is $970,800 in those areas. The loan limit is calculated slightly differently in Alaska, Hawaii, Guam, and the U.S. Virgin Islands, where a baseline limit of $970,800 also applies to loans for one-unit properties in 2022.

Pros and Cons of Conforming Loans

Pros
  • Manageable loan size

  • Lower interest rate

  • Potential for a smaller down payment

  • You don't need perfect credit

Cons
  • Restrictive loan limits

  • Harder for debt-burdened, poor-credit borrowers to get

Pros Explained

The advantages of getting a conforming loan include:

  • Manageable loan size: The conforming loan limit encourages homebuyers to buy a house they can afford, which may reduce the risk of default and foreclosure.
  • Lower interest rate: Conforming loans tend to carry lower interest rates, which can save a consumer a bundle over the life of the loan.
  • Potential for a smaller down payment: A down payment of at least 20% is desirable because it avoids the need for mortgage insurance, but both Fannie Mae and Freddie Mac back loans with loan-to-value ratios (the portion of the loan not covered by the down payment) of as high as 97%, or a down payment of as low as 3%.
  • You don't need perfect credit: Fannie Mae and Freddie Mac establish a minimum FICO score of 620 for the mortgages it backs, which translates to an attainable score of "fair" or better.

Cons Explained

The drawbacks of conforming loans include:

  • Restrictive loan limits: The conforming loan limits may be too restrictive for your needs, such as if you plan to buy a luxury home, and you may live in an area where conforming jumbo loans with higher limits aren't available.
  • Harder for debt-burdened, poor-credit borrowers to get: Fannie Mae and Freddie Mac reduced the debt-to-income ratio after the financial crisis of 2008 to curb risk. This action and the minimum credit score requirement mean that borrowers with too much debt relative to their incomes, or those with poor credit, may have difficulty getting conforming loans.

Conforming vs. Conventional Non-Conforming Loan

Conforming loans are the most popular type of conventional loan, which is any loan not insured or backed by the government. Another type of conventional loan is a non-conforming loan, which is a mortgage that doesn't adhere to these loan limits and rules.

Instead, the limits and terms of non-conforming loans vary greatly by lender and by the type of non-conforming loan. Non-conforming jumbo loans typically exceed the limits of conforming jumbo loans, maxing out at $1 to $2 million in 2019. These loans may come with higher down payment and credit requirements, but they may be suitable for those buying high-priced luxury homes.

Non-conforming loans are those of any size. Some are geared toward low-income buyers. Others are geared toward those with complex finances, such as the self-employed, or properties with non-standard features, such as those with more than 10 acres. They tend to come with higher interest rates and can be risky.

Conforming loan Conventional non-conforming loan
Adheres to guidelines set by the FHFA, Fannie Mae, and Freddie Mac Doesn't adhere to the aforementioned guidelines
Lower loan limits Loan limits may be higher than conforming loan limits
Lower interest rates and potential for smaller down payments Higher interest rates and down payments
Better suited for the average buyer Better suited for those with complex finances or non-standard properties

A conforming loan makes sense for average homebuyers. These loans often provide you with the best terms as long as you meet credit requirements, as long as you’re within the loan limit and meet the basic underwriting criteria.

Key Takeaways

  • A conforming loan is a mortgage that conforms to FHFA loan size limits and other rules set by Fannie Mae and Freddie Mac.
  • Loans must adhere to the requirements in order to be later sold to Fannie Mae and Freddie Mac, which ultimately adds liquidity and stability to the mortgage market.
  • The conforming loan limit varies by U.S. county, and it changes annually to reflect increases or decreases in average home prices in the U.S.
  • Conforming loans are beneficial to borrowers because of their manageable loan size, lower interest rate, and the potential for smaller down payments, but the limit may be restrictive for some.
  • Conforming loans are a more common and appropriate type of conventional loan for average buyers than non-conforming loans, which have non-standard loan size limits.

Article Sources

  1. The Federal Reserve Board. "The Influence of Fannie and Freddie on Mortgage Loan Terms." Accessed Dec. 18, 2021.

  2. Fannie Mae. "Eligibility Matrix," Page 1. Accessed Dec. 18, 2021.

  3. Consumer Financial Protection Bureau. "What Happens if My Mortgage Is Sold? Is My Loan Safe?" Accessed Dec. 18, 2021.

  4. Federal Housing Finance Agency. “FHFA Announces Conforming Loan Limits for 2022.” Accessed Dec. 18, 2021.

  5. Fannie Mae. "97% Loan to Value Options." Accessed Nov. 29, 2020.

  6. Freddie Mac. "Reach Your Dreams With 3%." Accessed Nov. 29, 2020.

  7. Freddie Mac. "Additional Requirements for Borrowers With Usable Credit Scores." Accessed Nov. 29, 2020.

  8. Fannie Mae. "Selling Guide." Accessed Nov. 29, 2020.

  9. Fannie Mae. "Guaranteed Mortgage Pass-Through Certificates (Single-Family Residential Mortgage Loans," Page 70. Accessed Nov. 29, 2020.

  10. Consumer Financial Protection Bureau. "Conventional Loans." Accessed Nov. 29, 2020.