Conforming vs. nonconforming loan: What’s the difference?
Your property price, credit history and other factors will determine what you need
Buying a new home is one of the most exciting events in your adult life, but it also comes with an entirely new set of vocabulary words to learn. It’s not uncommon to come across the terms conforming and nonconforming loans, and while these may sound like nothing more than industry jargon, they’re worth paying attention to as a buyer.
Mortgages fall under one of these two categories, which means understanding the key difference between a conforming versus nonconforming loan will benefit you as you finalize your mortgage options.
- A conforming loan is a mortgage that falls within the lending limits of the Federal Housing Finance Agency and meets the underwriting guidelines set by Fannie Mae and Freddie Mac.
- A nonconforming loan is any mortgage that doesn’t meet these requirements.
- The decision to choose a conforming loan versus a nonconforming loan may come down to the purchase price, the qualifications needed to obtain a loan and the down payment requirements.
What is a conforming loan?
A conforming loan is a mortgage that falls within the lending limits set forth by the Federal Housing Finance Agency (FHFA) and meets the guidelines set by Fannie Mae and Freddie Mac. These companies guarantee most U.S. mortgages. A conforming loan is a conventional one, which simply means no government agency backs it.
Although the government doesn’t back conforming loans, the FHFA sets the amount borrowers can borrow every year (each county has a designated borrowing limit). For 2023, most of the country falls under the baseline limit of $726,200. The FHFA increases loan limits for certain parts of the country, such as Alaska, California and Hawaii, where the cost of living is higher. The limit increases up to $1,089,300 in these designated areas.
Fannie Mae and Freddie Mac mortgage financing companies back conforming loans and are the most common loan type. Loans through Fannie Mae and Freddie Mac have their own unique requirements for borrowers.
Conforming loan requirements
Fannie Mae and Freddie Mac loans require all buyers to meet certain criteria for loan approval, including a minimum credit score, income and work history, debt-to-income (DTI) ratio and down payment requirements.
Although lenders may have their own specific requirements, the baseline criteria for conforming loans include:
- A minimum credit score of 620
- Total DTI ratio of 45% or less
- At least a 3% down payment
- Income limits
- Cash reserves
The exact criteria not only depend on the lender, but also on which specific Fannie Mae or Freddie Mac loan you’re applying for.
“When you think of conforming or conventional loan limits, which are set specifically to the state and county of the property, we need to know these are standard guidelines and offered consistently amongst lenders," explained Jim Black, a lending expert with Calque, Inc. "So, a conforming loan rate will only differ by a small amount relative to a competitive lender."
» MORE: What is a conventional mortgage?
Pros and cons of conforming loans
Various loan options are available in the marketplace, from conforming loans backed by Fannie Mae and Freddie Mac to government-backed options like FHA, VA, USDA and others. If you’re considering a conforming loan, carefully evaluate the pros and cons before deciding which loan is best for you.
Here are some of the pros of conforming loans:
- Lower interest rates: Since the credit score requirements are stricter, the interest rates are often lower with conforming loans versus other mortgage options.
- Low down payment options: There are multiple conforming loan products available, some of which only require a 3% down payment, such as the 97% LTV standard loan.
- Most common loan type: Because conforming loans are the most common, lenders are quite familiar with the requirements. This gives potential homebuyers more options to shop around and compare lenders.
Here are some of the cons of conforming loans:
- Possible mortgage insurance requirement: Conforming loans have lower requirements for a down payment, but if you put down less than 20%, the lender may require private mortgage insurance (PMI) . PMI is an extra fee tacked on to the principal and interest, which means your monthly payment is higher. It offers greater protection to the lender if you default on the loan.
- Borrowing limits: The FHFA sets borrowing limits for conforming loans, and Fannie Mae and Freddie Mac loans must adhere to these limits. The borrowing limit for 2023 is $726,200 for most of the country. It’s higher in areas with higher-than-average housing costs.
- Stricter requirements for some loans: There may be strict qualification requirements depending on the specific type of conforming loan you choose. This includes a minimum credit score of at least 620 and a stable income and work history.
What is a nonconforming loan?
A nonconforming loan is one that doesn’t adhere to the Fannie Mae and Freddie Mac requirements. Examples of these loans include jumbo loans or government-backed loans.
Nonconforming loan requirements
The requirements for nonconforming loans vary and depend on the exact loan product. For instance, jumbo loans often require a larger down payment of at least 20% and higher cash reserves for loan approval. Government-backed loans have various requirements, too, such as VA loans, which require borrowers to meet minimum service criteria.
» MORE: FHA vs. VA loans
Pros and cons of nonconforming loans
Nonconforming loans offer multiple advantages for borrowers, from higher borrowing limits to down payment assistance options. However, borrowers might not know the potential drawbacks.
- Higher borrowing limits: A nonconforming loan is the most likely option for anyone purchasing a property greater than the conforming loan limit set for the county. Since most of the country falls within the $726,200 conforming loan limit, the borrower must use other loan options when the purchase price exceeds the limit.
- Additional advantages: Government-backed loans often offer numerous advantages to those who qualify. For example, a VA loan includes a no down payment option, low interest rate, lower closing costs and no PMI, which could make it easier for someone to close on a home loan.
- Some options for borrowers with poor credit: There are a few nonconforming loan options for potential homebuyers with poor credit scores and credit history. While these loans are often riskier and more expensive than conforming options, they offer an opportunity for someone who might not qualify for a loan otherwise.
- May use strict credit requirements: Some nonconforming loan options have stricter credit requirements versus a conforming loan. Jumbo loans or mortgages for the self-employed are examples of these.
- Larger down payment requirement: Jumbo loans are another example of loans requiring a larger down payment. Again, it depends on the nonconforming loan you’re applying for, but be aware that some loan products require at least a 20% down payment – or more.
- Nonconforming loans might carry greater risk: While all mortgages involve some level of risk for both the lender and borrower, nonconforming loans that are not government-backed carry greater risk. During the 2008 housing crisis, the loans that caused the most trouble for borrowers fell under the nonconforming loan category.
Which should you choose?
One of the biggest factors when deciding between a conforming versus nonconforming loan is the property's purchase price. If you need a loan higher than the $726,200 borrowing limit (or whatever it is for the particular area), you may have no choice but to go with a nonconforming loan, such as a jumbo loan option.
If you’re trying to save as much money as possible over the life of the loan, a conforming loan is likely the better choice. Lower interest rates mean you can save thousands of dollars over a 30-year term.
Government-backed, nonconforming loans may be a better option for someone who needs down payment assistance or might not meet higher credit requirements. Although these loans are often more expensive, the special programs offered by government-backed loans can get people into houses that otherwise might not be possible.
“In any instance, a great local mortgage lender will be able to offer a custom home loan solution, evaluating both conforming and jumbo strategies,” said Black. “As a mortgage adviser, one must always look for the best solution for the borrower’s [interest], not necessarily what is in the best interest of the bank.“
Is a conforming loan the same as a conventional loan?
A conventional loan is not backed by any government entity and is a type of conforming loan. While all conforming loans fall under the classification of a conventional loan, not all conventional loans are conforming.
Are there income requirements for a conforming loan?
Obtaining a conforming loan requires you to submit at least two months of pay stubs and W2s from the last two years. This is to show the lender proof of income and stable work history. The lender may require other income source documentation, such as a Social Security award letter or 1099s.
Are conforming loan limits the same nationwide?
The FHFA sets the conforming loan limits every year and establishes the limits county by county across the country. Most counties in the U.S. fall under the baseline amount set by the FHFA, however, there are counties where housing is much more expensive than the national average, and the FHFA increases the borrowing limits in these places.
- Consumer Financial Protection Bureau, “ What are Fannie Mae and Freddie Mac? ” Accessed May 25, 2023.
- Consumer Financial Protection Bureau, “ Conventional Loans .” Accessed May 25, 2023.
- Federal Housing Finance Agency, “ Fannie Mae and Freddie Mac .” Accessed May 25, 2023.
- Consumer Financial Protection Bureau, “ What is Private Mortgage Insurance? ” Accessed May 25, 2023.
- U.S. Department of Veterans Affairs, “ VA Home Loans .” Accessed May 25, 2023.
- Fannie Mae, “ Eligibility Matrix .” Accessed May 25, 2023.
- Federal Housing Finance Agency, “ Conforming Loan Limit (CLL) Values .” Accessed May 25, 2023.
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