Understanding Conforming and Non-Conforming Loans
First things first
Buying a house should be exciting, not overwhelming. So, we’ve broken down the differences between these types of loans so you can better understand the housing market and how it affects your buying or selling potential.
A conforming loan is a conventional mortgage loan that complies with the financing limits set by the Federal Housing Finance Agency (FHFA). A conforming loan “conforms” to the underwriting guidelines set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). These are government-sponsored entities created to give people a fair opportunity to purchase housing without creating an undue risk for taxpayers. Both Fannie Mae and Freddie Mac are legally obligated to buy conforming loans.
Conforming loans have a pre-determined limit decided by FHFA. And how’s this limit determined? Largely based on where you live.
So, what does a conforming loan offer for buyers?
- It meets loan limits set by the FHFA
- It’s currently capped between $510,400 and $765,600
- Lower interest rates
- Lower monthly mortgage payments
- Less money spent over the life of your loan
- Lower down payments
- Lower credit scores accepted
- Easier to qualify for than a conventional loan
A nonconforming loan is sometimes called a “jumbo” loan. A jumbo loan’s limits exceed the conforming loan limits, letting you borrow more money towards a home. These are generally issued to higher-income earners and often require larger minimum down payments. A nonconforming loan’s underwriting does not conform to Fannie Mae or Freddie Mac loan structures. Because these loans do not meet FHFA guidelines, they are not insured by Fannie Mae or Freddie Mac. And because they aren’t insured, they’re considered higher risk.
So, what does a nonconforming loan offer for buyers?
- Does not have a specific cap
- Allows buyers to purchase more expensive properties
- Is not government insured
- Requires a larger down payment
- Demands a very high credit score
- Is more difficult to qualify for
What factors determine conforming loan limits?
Conforming loan limits were established by the housing Economic Recovery Act of 2008. The specific loan limit amount is determined by the FHFA House Price Index. For example, from Q3 2017 to Q4 2018, housing prices increased 6.9% on average, according to the FHFA 2018 House Price Index report. So, the maximum conforming loan limit was raised by the same amount in 2019, making it $484,350.
How do conforming loan limits affect you?
As a buyer, higher conforming loan limits mean you have an expanded pool of potential homes to purchase. The higher limit makes expensive homes more affordable for a broader range of potential buyers, giving you access to homes that may have been out of budget before.
As a seller, it’s good news when conforming loan amounts go up, because it suggests government confidence in the housing market. It could make it easier for you to sell your home as it can make potential buyers more comfortable making a purchase. Plus, as limits go up, the pool of potential buyers increases as more homes become accessible.