A conforming loan adheres to the guidelines set by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.
These guidelines specify the maximum loan amount, credit score, and debt-to-income ratio. The borrowers must meet these requirements to qualify for a conforming loan.
What is a Conforming Loan?
A conforming loan is a type of mortgage that meets the guidelines set by Fannie Mae and Freddie Mac.
Lenders prefer these loans because they typically have lower interest rates and are easier to sell on the secondary market.
To qualify, borrowers must meet certain criteria, including a good credit score, a low debt-to-income ratio, and a down payment of at least 3%.
How Do Conforming Loans Work?
Here are the steps to understand how conforming loans work:
- Borrower applies for a conforming loan: The borrower submits a loan application to a lender that meets the guidelines.
- Lender evaluates borrower’s creditworthiness: The lender evaluates the borrower’s credit score, income, and debt-to-income ratio to determine the eligibility criteria.
- Loan is originated: The lender originates the loan and provides the funds for the borrower to purchase the property.
- Loan is sold to Fannie Mae or Freddie Mac: Once the lender originates the loan, they can sell it on the secondary market to Fannie Mae or Freddie Mac.
- Borrower makes monthly mortgage payments: The borrower makes their monthly mortgage payments to the loan servicer, which may be a different company than the original lender.
- Loan is held or sold to investors: Fannie Mae or Freddie Mac may sell the loan to investors or continue to hold it.
It’s important to note that conforming loans have limits on the amount that can be borrowed.
What Makes a Mortgage a Conforming Loan?
To fully comprehend the present guidelines for conforming loans, it is necessary to review their evolution over time and understand the historical context that led to their establishment.
The Great Recession of 2008
During the 2008 Great Recession, mortgage lenders faced significant challenges due to the high number of mortgage defaults and foreclosures.
The widespread defaults and foreclosures played a significant role in causing the market crash and initiating the economic downturn.
The Formation of CFPB
Congress passed and then-President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act as a response to the 2008 recession.
The Consumer Financial Protection Bureau (CFPB) subsequently established rules aimed at safeguarding consumers and minimizing future defaults. The regulations included the TILA-RESPA Integrated Disclosures.
TRID mandates that lenders verify that borrowers can repay their loans and fully inform all borrowers about their mortgage expenses.
The New Rule
The Federal Housing Financing Agency (FHFA) directed Fannie Mae and Freddie Mac to ensure that their lenders adhere to all consumer protection regulations established by the CFPB, as well as their own internal guidelines.
Private lenders are still permitted to establish their own lending requirements and originate non-conforming loans.
What are Conforming Loan Limits?
Conforming loan limits are the maximum loan amounts that Fannie Mae and Freddie Mac will purchase from lenders. The Federal Housing Finance Agency (FHFA) determines these limits annually based on changes in the national average home price.
In 2021, the conforming loan limit for a single-family home is $548,250 in most areas of the United States, although it can be as high as $822,375 in certain high-cost areas.
The loan limits vary depending on the number of units in the property, with higher limits for multi-unit properties such as duplexes, triplexes, and four-unit buildings.
The FHFA adjusts the conforming loan limits each year to reflect changes in housing prices. Borrowers seeking to obtain a mortgage that exceeds the conforming loan limit may need to consider a jumbo loan, which typically comes with higher interest rates and stricter requirements.
Conforming Loans Vs. Nonconforming Loans
Conforming loans and nonconforming loans are two types of mortgages that differ in various ways.
Conforming loans are those that conform to the guidelines set by Fannie Mae and Freddie Mac. These loans typically have lower interest rates and more flexible lending requirements, making them easier to obtain for borrowers with good credit and stable incomes.
The Federal Housing Finance Agency (FHFA) determines maximum loan limits for conforming loans annually and adjusts them based on changes in home prices.
Nonconforming loans, on the other hand, do not meet the guidelines set by Fannie Mae and Freddie Mac. Borrowers who need to borrow more than the conforming loan limits allow, or who have unique financial circumstances that do not meet the strict criteria of conforming loans, typically use these loans.
Jumbo loans are another name for nonconforming loans, and they typically have higher interest rates and stricter lending requirements. Borrowers who are self-employed or have a high debt-to-income ratio may find it more challenging to obtain a nonconforming loan.
In summary, conforming loans are generally easier to obtain, have more flexible requirements, and have lower interest rates than non-conforming loans. However, nonconforming loans may be necessary for borrowers who require larger loan amounts or have unique financial circumstances.
Why Do Some Home Buyers Use Nonconforming Loans?
Some homebuyers may use nonconforming loans for several reasons, including:
- Larger loan amounts: Nonconforming loans are ideal for borrowers who require more money than the conforming loan limits allow. These loans allow borrowers to finance expensive properties or those in high-cost areas.
- Unique financial circumstances: Borrowers who have unique financial circumstances that do not meet the strict criteria of conforming loans may need to use nonconforming loans. For example, self-employed borrowers who have difficulty proving their income or those with a high debt-to-income ratio may find it easier to obtain a nonconforming loan.
- Investment properties: It is also used to finance investment properties, such as rental properties or second homes.
- These properties may not meet the requirements of conforming loans and may require nonconforming loan products.
- Time-sensitive transactions: Nonconforming loans may also be used for time-sensitive transactions, such as purchasing a property at auction or buying a property that requires extensive repairs.
The Bottom Line
Conforming mortgages offer lower interest rates and fees, as well as a more stable loan structure, which makes them a popular choice among many consumers.
We recommend that you read our comprehensive guide, “How to Buy a House,” to ensure that you have a complete understanding of the entire home-buying process.Uncategorized