What Is a Conforming Loan?
When you’re looking for a home mortgage, you might encounter something called a conforming loan. The conforming loans are mortgages that conform to rules set by Fannie Mae and Freddie Mac lending companies. The government agencies insured both these firms that own many of the home loans in the United States. The FHFA (Federal Housing Finance Agency) has established the standards for conforming loans, a traditional type of mortgage with limitations on loan amounts and minimum credit reports.
In contrast, non-conforming loans such as large loans or government-guaranteed loans—don’t meet the FHFA loan standards, so these loans are not purchased or owned by Fannie Mae and Freddie Mac. Here are more details about conforming loans.
How does the conforming loan work?
Conforming loan mortgages are the most common type of housing loan. Lending institutions widely offered these types of loans. However, unlike FHA, VA, USDA, and other home mortgages, they’re not insured or guaranteed by the federal government. Specific guidelines for obtaining conforming loans are listed below.
- Minimum FICO rating of 620.
- The debt-to-income ratio is nearly 45% (although high credit or large amounts of cash can make the proportion to 50%).
- Initial deposit as low as 3% of the loan amount.
- The credit amount should remain within the limits of Fannie Mae or Freddie Mac loans.
The most significant difference between conforming loans and non-conforming loans is the reduced borrowing limit. For 2021, the general limit to purchase a single-family home with conforming loans is $548,250, though the limit increases to $822,375 in some high-cost areas of the United States.
Pros and Cons of Conforming Loans
Similar to other types of loans, conforming loans come with potential benefits and drawbacks.
The potential advantages compared to non-conforming loans are:
- Easy documentation
- Lower rates of interest
- Less FICO rating requirements (620 versus 680 for most jumbo and non-conforming lendings).
- Lower deposit
Why is it simpler to obtain a conforming loan than a non-conforming loan?
Since conforming loans are less risky for lenders, therefore; they can offer these lendings to Fannie Mae or Freddie Mac. These two government-sponsored organizations ensure the stability of the U.S. home loan market by guaranteeing the repayment of loans and interests to borrowers.
According to Customer Financial Protection Bureau, many mortgage loans that troubled homeowners throughout the 2008 real estate crisis came under the non-conforming group.
In addition to reduced borrowing limits, a conforming loan may be more challenging to obtain if you have a reduced credit report or a high debt-to-income ratio. More so, conforming mortgages can limit the flexibility of the type of property you can purchase. For example, the credit limit of a conforming loan may prevent you from buying a house when you need to borrow more funds than the provided limit.
How to apply for conforming loans
Several lending companies offer both conforming and non-conforming mortgages. When you intend to apply for a conforming loan, remember that lenders will typically look for the following:
- Credit report of a minimum of 620.
- A debt-to-income ratio below 50%.
- The loan to value ratio must be near 97%, which results in a down payment of at least 3%.
To better prepare yourself for credit approvals, check your credit report and FICO scores to understand the type of credit you have and where you stand. It is also crucial to stop applying for new loans, postpone large purchases, reduce credit card debt, and pay bills quickly. All these steps help improve your credit score and increase your chances of getting a conforming loan.