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What Are Conforming Loans And What Do They Mean To Borrowers?

Lauren Nowacki5-minute read

December 02, 2021

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Conforming loans are the most common type on the market today and the most beneficial for both lenders and buyers. If you’re in the market to buy a home, it pays to learn how you can qualify for a conforming loan and save the most on your mortgage financing.

What Is A Conforming Loan?

Conforming loans are mortgages that meet Fannie Mae and Freddie Mac guidelines. Conforming lenders underwrite and fund the loans and then sell them to investors like Fannie Mae and Freddie Mac. Once securitized, the loans are sold to investors on the open markets. Because of their liquidity and the government regulations, conforming loans often have lower interest rates than non-conforming loans.

How Do Conforming Loans Work?

When buyers look at their mortgage options, they’ll come across many different types of mortgages, including FHA, VA, USDA, and conventional/conforming loans. It’s often difficult for buyers to see the difference between the loans when applying or even going through underwriting. Still, government-backed loans (FHA, USDA, VA) and conforming loans have much less onerous underwriting requirements than some types of nonconforming loans, such as jumbo loans.

Conforming loans have slightly stricter guidelines, but you’ll pay mortgage insurance (if applicable) for a shorter period and save more money over the life of the loan.

The Role Of Fannie Mae And Freddie Mac

You may wonder what the role of Fannie Mae and Freddie Mac are in all of this. If the lender underwrites and funds the loan, what do Fannie Mae and Freddie Mac do, and do you deal with them?

Both Fannie Mae and Freddie Mac provide long-term stability and liquidity to the U.S. mortgage and housing markets. Both entities have similar guidelines and missions, but they work with different markets. Fannie Mae buys mortgages from commercial (large) banks, and Freddie Mac works with smaller (private) banks and credit unions.

Both entities 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. However, as a practical matter, nothing should change because the servicing of your loan isn’t impacted even after the sale. You make your payment to the same entity.

The Secret Afterlife Of Conforming Mortgages

Most buyers don’t think about what happens after their closing. They know they must make payments, but they don’t realize what happens with their mortgage. Truth be known, the afterlife of a mortgage is only beginning at the closing.

Fannie Or Freddie Buys Your Mortgage

After you close on your mortgage, the title company overnights the documents to the lender’s post-closing department. The professionals there check to make sure you signed all the documents correctly and provided any requested information.

If there are any issues, the lender will reach out to you to fix the errors. Once ready, the loan is sent to Fannie Mae or Freddie Mac to purchase. The investor does their check on your loan documents, asks for clarification on anything they need, and then they upload the loan into their system and pay the lender for the loan.

This process is essential for lenders because it provides more liquidity. Without Fannie Mae or Freddie Mac buying the loans, lenders wouldn’t have enough capital to keep writing loans.

Your Mortgage Joins Other Mortgages Just Like Yours

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. This steady flow of mortgage-backed securities creates a secondary mortgage market and keeps up the demand for new mortgages.

Investors Buy Securities That Convert Your Payments Into Their Retirement Incomes

Your mortgage payment is an investor’s income. Many use this for investment income or other large financial goals. Investors buy mortgage-backed securities and earn interest on the payments you make.

What Makes A Mortgage A Conforming Loan?

To understand the current conforming loan rules, we need to look back.

Subprime Mortgages And The 2008 Great Recession

The 2008 Great Recession was a tough time for everyone, especially mortgage lenders. The vast number of mortgage defaults and foreclosures played a role in the recession. While not wholly responsible, the turn of events from many defaults caused the market to crash and the Recession to start. 

The Consumer Financial Protection Bureau Is Formed

In response to the 2008 recession, Congress passed, and then-President Obama signed, the Dodd-Frank Wall Street Reform and Consumer Protection Act. The CFPB created rules that protected consumers and helped prevent future defaults. The rules included the TILA-RESPA Integrated Disclosures (TRID), which ensures all borrowers understand their mortgage costs and the lender verifies they ensured the borrower could repay the loan.

New Rules Limit The Types Of Mortgages The Enterprises Will Buy

The Recession also helped the FHFA, Federal Housing Financing Agency, mandate Fannie Mae and Freddie Mac to require their lenders to comply with all CFPB consumer protections. This is in addition to any Fannie Mae or Freddie Mac rules.

Private lenders are still free to create their own rules and originate non-conforming loans, but Fannie Mae and Freddie Mac cannot buy them.

What Are Conforming Loan Limits?

Fannie Mae and Freddie Mac have conforming loan limits. This means you can’t borrow more than the limit for that year unless you’re buying in a high-cost area with higher limits. Any borrower that needs more than the conforming loan limits will need a nonconforming loan, such as a jumbo loan.

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Conforming Loans Vs. Nonconforming Loans: Which Is Better?

Home buyers typically have two options when looking for financing: conforming and nonconforming loans. Conforming loans are backed by Fannie Mae and Freddie Mac, and nonconforming loans are not, but there are other significant differences too.

For Lenders

To get Fannie Mae or Freddie Mac to invest in their loans, lenders must comply with all consumer protection regulations. Doing so ensures Fannie Mae or Freddie Mac will buy the loans, giving the lender more liquidity.

Lenders also enjoy following the regulations because it makes the loan less risky, and less risk means lenders can charge buyers less in fees and/or interest rates.

For Home Buyers

Home buyers benefit from the regulations, too. The expanded disclosures give them more information, and they can enjoy lower fees and interest rates. Consumers also know the loan is safe for them and that they demonstrate the ability to repay the loan. With Fannie Mae’s participation in the mortgage market, lenders can write loans with longer terms, making loans more affordable for buyers.

Why Do Some Home Buyers Use Nonconforming Loans?

Not all buyers qualify for conforming loans. You’ll need a nonconforming loan from a private lender in the following situations:

  • You need a higher loan amount than the conforming loan limit.
  • Your credit doesn’t meet the requirements.
  • You have other extenuating circumstances that Fannie Mae or Freddie Mac won’t allow.

The Bottom Line: Conforming Loans Offer Greater Consumer Protections And Lower Interest Rates

Many consumers benefit from conforming mortgages because of the lower rates and fees and the stability of the loan. If you’re thinking about buying a house, read our guide “How to Buy a House,” to make sure you know everything there is to know about the process.

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Lauren Nowacki

Lauren Nowacki is a staff writer specializing in personal finance, homeownership and the mortgage industry. She has a B.A. in Communications and has worked as a writer and editor for various publications in Philadelphia, Chicago and Metro Detroit.