Conforming Loan vs Non-Conforming Loan

March 23, 2021 | 8 Minute read

Conforming Loans and Non-Conforming Loans Explained

When shopping around for a mortgage, it’s vital that you understand the different types of loans available to you. Finding the right loan, from the right lender, can help you to secure your dream home. Besides conventional options, there are non-conventional loans that can help you get your foot on the property ladder.

Conforming loan? Non-conforming loan? Conventional? Unconventional? We’re not surprised how many people are confused by these pieces of mortgage jargon. However, all of these terms are important, as they could help you buy your first property.

That said, there are important differences between the types of loans available. If you’re trying to secure a mortgage, you need to have a solid grasp of these differences before making a purchasing decision.

Don’t worry.  In this guide, we’ll explain the different types of loans available in layman’s terms. Read on to find out what a conforming loan is, how they work, and how they compare to non-conforming and conventional loans.

What is a Conforming Loan?

A conforming loan is a type of mortgage that meets all requirements to be purchased by Fannie Mae or Freddie Mac. The main eligibility criterion is that the total loan amount is less than the annual determined dollar cap set for your county.

In layman’s terms, a conforming loan is a mortgage loan whose amount stays beneath a certain dollar cap. This dollar cap is determined by the Federal Housing Finance Agency (FHFA), which is responsible for regulating Fannie Mae and Freddie Mac, two government-sponsored enterprises (GSEs).

Fannie Mae and Freddie Mac were created decades ago in a bid to boost U.S. homeownership. These enterprises achieve this goal by buying mortgages from lenders and selling them or keeping them on their own books.

Either way, Fannie Mae and Freddie Mac typically pay lenders for their mortgages. Once paid, the lenders can issue additional mortgages and other types of financial loans. Mortgage issuers across the U.S accept Fannie Mae and Freddie Mac guidelines. This makes loans that conform to their standards easier to buy, sell, and package into mortgage-backed securities, which can be traded on specific financial markets.

How Conforming Loans Work

As mentioned above, conforming mortgage loans are set by The Federal National Mortgage Association (FNMA/Fannie Mae) and the Federal Home Loan Mortgage Corporation (FHLMC/Freddie Mac), two government-sponsored entities that fund and drive the market for the majority of U.S home loans.

These governmental agencies have set standardized guidelines and rules to which mortgages for single-family/one-unit properties must conform in order to be eligible for financial backing. Neither Fannie Mae nor Freddie Mac issue mortgages. Instead, they provide insurance for mortgages issued by lenders. They also act as secondary market-makers for lenders that want to sell mortgages.

These GSEs have specified criteria that outline the types of loans they will purchase because they won’t take any risks when purchasing a mortgage. For this reason, Fannie Mae and Freddie Mac won’t buy loans that fail to meet their requirements.

The term ‘conforming loan’ is used most frequently when discussing mortgage amounts, which have to fall beneath a capped limit, called the conforming loan limit, which is set by the FHFA.

About the Conforming Loan Limit

Now, you’re probably wondering, ‘what is the conforming loan limit?’ Conforming loan amounts change from year to year, meaning that conforming mortgage limits also fluctuate.

If a conventional loan is considered a conforming loan, the total loan amount must be less than the FHFA limit.
For 2021, the FHFA has set the baseline conforming loan limit at $548,250 for single-unit properties. So, if you want to find a mortgage for a house that costs more than this amount, you’ll have to look for a non-conforming loan. That said, this limit has certain exceptions. For example, in cities with higher home values like San Francisco, CA, conforming loan limits increase to $822,375.

Another example is San Diego, CA. Due to its relatively high property prices, this area’s conforming loan limit is $753,250.
If you want to know the conforming loan limit in your county, access the FHFA’s interactive map tool. In practice, let’s imagine you want to buy a one-unit property in Sacramento, CA, for $475,000, and you choose a conventional loan of $525,000 to finance the sale. As your loan falls below the loan limit of $598,00, your mortgage would be considered a conforming loan.

Conforming vs. Non-Conforming Loans

You’re probably wondering, ‘What is a non-conforming loan?’

If you look for a conventional loan that fails to meet the criteria to be purchased by Fannie Mae or Freddie Mac, the loan is considered a non-conforming loan. A popular type of non-conforming loan is called a ‘jumbo loan.’ Jumbo loans are loans that are higher than the conforming loan limit.

Jumbo vs. Conforming Loan

Let’s go back to the house in Sacramento, but this time imagine the property costs $800,000. You can afford a down payment of 20%, equating to $160,000, and you’ll be paying the remaining balance of $640,000 with a mortgage loan. The fact that this loan amount is higher than the 2021 conforming loan limit for the Sacramento, California area means you’ll require a non-conforming jumbo loan to complete this purchase. In most cases, the required down payment and interest rates are higher for non-conforming loans.

Additionally, borrower eligibility differs from lender to lender for these large mortgages.
Non-conforming loans typically mean:

  • A minimum down payment of 20% or more.
  • A higher mortgage interest rate.
  • Stricter credit-qualifying criteria, with added scrutiny of your income and credit

When discussing jumbo vs. non-conforming loans, it’s important to note that exceptions apply to the 20% minimum down payment standard. Some lenders will accept 10% down on a jumbo loan. However, debt-to-income (DTI) plays a critical role in jumbo loans. The DTI cut off is 43%. (The DTI cutoff for conforming loans is 50%.)

A low DTI ratio is very important when you get a jumbo loan because it tells lenders that you will have enough cash flow to cover your mortgage payments. For example, when securing a jumbo loan from Quicken Loans, you’ll need a DTI between 38% – 43% in order to qualify.
Conforming loans are advantageous for consumers because of their low-interest rates. For example, when a first-time homebuyer takes out an FHA loan, their down payments can be as small as 3.5%. That said, mortgage insurance of around 0.85% per year on 30-year loans equal to or less than $625,000 is required on loans with such minimal down payments.
Lenders tend to favor working with conforming loans, as they can be sold on the secondary mortgage market as investment bundles. This process helps make room for a financial institution to issue more loans and lend additional money to home buyers.

Conforming Loan vs. Conventional Loan

Conforming loans frequently get confused with conventional mortgages/loans. Although these types of mortgages are similar, they are not the same. Conventional mortgages have much broader categories. They are any loans offered via private lenders, as opposed to government-backed agencies like the U.S. Department of Veteran Affairs, the FHA, or backed by Fannie Mae or Freddie Mac.

This is where overlap and confusion often occurs. The size of a loan doesn’t impact its conventionality, just its conformality. In effect, all conforming loans are conventional; however, not all conventional loans can qualify as conforming.

Special Considerations for Conforming Loans

Every year, the conforming loan limit is set by the FHFA. They provide regulatory oversight to make sure that Fannie Mae and Freddie Mac are true to their missions and charters promoting homeownership for middle-class and lower-income Americans.

The FHFA compares October to October percentage increases and decreases in average housing prices by looking at the Monthly interest Survey (MIRS). Using this information, they then adjust the conforming loan limits for the year ahead.

To carry out this survey, the FHFA asks a large sample of mortgage lenders to report the terms and conditions on all fully amortizing, purchase money, single-family, non-farm loans that they close over the last five business days of the month.

The information collected provides information on loan terms, interest rates, loan types, lender types, house prices by property type, and information on 15 and 30-year fixed-rate loans.

As mentioned above, your financial situation, loan amount, and a range of other factors determine the type of loan for which you qualify. That said, there are occasions when the borrower has a choice. In any case, you must follow the best-practices: Compare lenders to understand different fees, rates, programs, and the quality of their offers.

Reali Can Help

Now that you know the difference between conforming, non-conforming, conventional, and jumbo loans; we can help you access financing to purchase your first property.

Our expert team of credit and finance professionals has spent decades helping people navigate the mortgage industry and access financing when they want to buy a home.

For additional information about current loan programs and limits, to apply for a home loan online, or to refinance your property, contact a member of our team today. We’re happy to answer any questions you have about home loans, with no obligation necessary.

Reali has selling and buying solutions tailored to fit your needs. Find out more today!