What are conforming loans and what do they mean to borrowers?

Conforming loans are the most common type of mortgage in the United States. Issued by private lenders, conforming mortgages meet federal requirements that allow lenders to sell those loans to Fannie Mae and Freddie Mac. This provides the lender with more money to loans with. As a borrower, conforming loans may be more challenging to qualify for than government-backed loans, but they usually are less expensive. Let’s take a closer look at what is a conforming loan, and how a conforming loan works to help you determine if this is the right type of mortgage for you.

What’s a conforming loan?

Conforming loans are private mortgages that meet rules set by Fannie Mae, Freddie Mac, and their regulator, the Federal Housing Finance Agency. The rules establish a maximum loan amount, a minimum down payment, a minimum credit score, and a maximum debt-to-income ratio.

Lenders can sell loans that conform to those rules to Fannie Mae and Freddie Mac, which are government-sponsored enterprises that support the mortgage market.

Conforming loans are less risky for lenders because they know they can sell them to Fannie Mae or Freddie Mac.

Guidelines for Fannie Mae

Fannie Mae and Freddie Mac each set their own requirements. For a loan to conform to Fannie’s guidelines, it must meet the following criteria.

Guidelines for Freddie Mac

Freddie Mac’s conforming loan guidelines are similar to those of Fannie Mae, but have slight differences.

What are conforming loan limits?

Fannie Mae and Freddie Mac have conforming loan limits that set the maximum amount you can borrow with this type of loan for properties with one to four units.

Each year, the Federal Housing Finance Agency sets a limit for most areas and a higher limit for high-cost areas, Alaska, Hawaii, Guam, and the U.S. Virgin Islands.

Any borrower who requires a loan amount exceeding the conforming loan limits will need a nonconforming loan, such as a jumbo loan.

A brief history of conforming loans 

To understand why conforming loan rules are structured this way, it helps to look back. Here’s a quick recap of the history of conforming loans:

• Fannie Mae is founded. Congress created Fannie Mae in 1938 as part of the New Deal to provide federal funds to banks to encourage more home loans.
• Freddie Mac is founded. In 1970, the government founded Freddie Mac as a competitor to Fannie Mae, which was now authorized to buy conventional loans from private lenders.
• The 2008 recession. The 2008 recession was triggered in part by a wave of mortgage defaults and foreclosures. Fannie and Freddie were taken over by the federal government.
• The Consumer Financial Protection Bureau was formed. The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed by Congress and signed into law by then-President Obama in 2010. The CFPB created rules to protect consumers and prevent future defaults. The rules included the TILA-RESPA Integrated Disclosures, which ensure that all borrowers understand their mortgage costs and require lenders to verify that the borrower can afford to repay the loan.
• The Federal Housing Financing Agency mandates new rules. The FHFA was created to stabilize the housing market. Fannie Mae and Freddie Mac require lenders to comply with all CFPB consumer protections. Requiring conforming loans to meet specific guidelines reduces the risk of default and helps protect borrowers, lenders, the housing market, and the economy.

How do conforming loans work?

Conforming loans originate with private lenders, who will ensure during underwriting that the loan meets all the required conditions.

Once the loan closes, the lender can sell the loan to Fannie Mae or Freddie Mac, which packages conforming loans into mortgage-backed securities that can be sold on the secondary market. Fannie Mae buys mortgages from large, commercial banks, and Freddie Mac works with smaller banks and credit unions.

Both Fannie and Freddie work behind the scenes. You won’t have any contact with them, nor will you know when your loan is sold to them until you get your investor letter. Nothing should change for you because the servicing of your loan isn’t affected even after the sale. You make your payment to the same entity.

Because conforming loans aren’t government-backed, they can be more challenging to qualify for. However, they pose less risk to the lender, which means they often come with lower interest rates and are usually cheaper overall than other types of loans.

The conforming loan process 

Most buyers probably don’t think about what lenders do with their mortgage after closing. Here’s an overview of what happens to conforming loans after closing.

1. You close on your mortgage. On closing day, you’ll sign all the necessary documents to make your mortgage official, and the title to the home will be transferred into your name.
2. The title company sends documents to the lender’s post-closing department. The title company overnights the documents to be verified and checked for completeness and accuracy.
3. The lender contacts you for any needed corrections. If any issues arise, the lender will contact you to resolve the errors.
4. The loan is bought by Fannie Mae or Freddie Mac. This process is essential for lenders because it provides liquidity. Without this sale, lenders wouldn’t have enough capital to keep writing loans.
5. Fannie Mae or Freddie Mac bundles loans like yours and securitizes them for sale to investors. Mortgage-backed securities can have as many as 1,000 loans in them, providing investors with a steady income. 
6. An investor buys the security that your loan is part of. This steady flow of mortgage-backed securities creates a secondary mortgage market, which in turn sustains demand for new mortgages.
7. Investors earn income from your mortgage payments. Another reason investors buy mortgage-backed securities is that they earn interest on these payments.

Conforming loans vs. nonconforming loans: Which is right for you?

A nonconforming loan can be an option for borrowers who don’t qualify for a conforming loan, but these loans don’t have the same protections. Plus, nonconforming loans tend to be more expensive. Let’s look at the pros and cons of conforming vs. nonconforming loans.

Pros of conforming loans

Conforming loans can come with some considerable benefits if you meet the eligibility requirements. Some of the advantages of conforming loans:

• Because conforming loans can be sold to Fannie Mae or Freddie Mac, they pose less risk to the lender, allowing them to charge lower interest rates.
• Conforming loans tend to cost less overall than government-backed loans.
• Fannie Mae and Freddie Mac’s eligibility requirements are designed to offer more protection for borrowers and safer loan terms.
• You can get a conforming loan for a down payment as low as 3%. FHA loans require a minimum down payment of 3.5% and jumbo loans require a down payment of at least 10%.
• When Fannie Mae and Freddie Mac purchase conforming loans, they provide the financing that enables lenders to make more loans.

Cons of conforming loans 

Conforming loans can also come with certain downsides, such as:

• You can’t borrow more than the conforming loan limit set by the FHFA for your area.
• Stricter eligibility requirements than government-backed loans mean you may have trouble getting a conforming loan if your credit score is less than 620.
• If your down payment is less than 20%, you’ll need to purchase private mortgage insurance, also known as PMI.

Pros of nonconforming loans

Some of the perks of nonconforming loans include:

• They’re an option for borrowers who are ineligible for a conforming loan.
• You can borrow more than the conforming loan limit.
• More accessible for borrowers with non-traditional income sources.

Cons of nonconforming loans

It’s important to be aware of the potential risks and downsides of nonconforming loans, which can include:

• Higher interest rates because lenders take on more risk.
• Fewer consumer protections.
• Higher costs for borrowers.
• Potentially risky loan features.

The bottom line: Conforming loans offer consumer protections and lower interest rates

Because conforming loans meet Fannie Mae and Freddie Mac’s guidelines, borrowers can benefit from lower interest rates and more protections. That is, of course, if you meet the eligibility criteria. Borrowers with a higher credit score and a down payment can save money with a conforming loan.

If you think a conforming loan might be right for you, get started on your mortgage application today.