All conforming loans are conventional loans, but not all conventional loans are conforming loans. Then, there’s the case of non-conforming mortgages. They are not exactly polar opposites but their features can make a difference.
This is spelled out in down payments, interest rates and credit scores that affect your loan prospects. Knowing about conforming and non-conforming mortgages for home buying and refinancing is a step to a clearer path toward homeownership.
Of Conforming and Non-Conforming Mortgages
Mortgages are broadly classified as conventional and government loans. Conventional loans are not backed or guaranteed by any government agency. Loans backed by the FHA, VA and USDA are government loans.
Conventional loans, for example, are sold in the secondary market. Fannie Mae and Freddie Mac are the biggest investors who buy loans that they securitize. Loans that conform to standards set by Fannie or Freddie are thus called conforming mortgages.
Other conventional loans don’t contain traits that make them eligible for a Fannie Mae or Freddie Mac purchase. These loans are thus called non-conforming loans.
Loan Limits and Mortgages
What makes a loan conforming is its loan size. The Federal Housing Finance Agency, regulator of Fannie Mae and Freddie Mac, sets the maximum amount a consumer can borrow. For Fannie/Freddie to buy a loan, it must be within the conforming loan limit.
In 2017, the FHFA increased the maximum loan limit to $424,000 for one-unit homes in most counties in the U.S. This is higher in counties with expensive homes like Alameda, CA where the maximum loan limit for a single-unit property is $636,150.
Not all homes have price tags within the conforming loan limits. Second homes, luxury properties and other real property investments are just some examples. This is where jumbo loans exceeding the conforming loan limit come in.
Perks and Possible Pitfalls
Each of the conforming and non-conforming loans has these perks.
- Conforming loans – With the GSEs’ backing in place, lenders can make conforming loans at lower rates for those with excellent credit. Lower rates mean lower monthly mortgage payments. Conforming loans are also relatively easier to qualify, including down payments as low as 3% for special first-time homebuyers programs.
- Non-conforming loans – With no agency restrictive guidelines, non-conforming lenders can approve borrowers with credit issues and high debt-to-income ratios. Jumbo loans are ideal for borrowing higher amounts.
Conforming loans adhere to risk-based pricing called loan-level pricing adjustments (LLPAs) in determining the mortgage rate given to a borrower. These LLPAs vary by credit scores, loan-to-value ratios, and the property’s number of units. Borrowers generally need to have excellent credit to qualify for lower rates and negotiate other loan costs.
Meanwhile, the bigger loan size makes jumbo loans riskier for lenders. To offset this risk, lenders may require down payments of at least 20%, higher interest rates, and more-than-average credit profile. As noted above, the nonconforming label can apply to loans where there are credit issues, high DTI ratios, and low down payments on a case-to-case basis.
Having a conforming or non-conforming loan has its implications. So, which is the most beneficial for you?