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What is the Difference Between a Conforming Loan & Non-Conforming Loan?

Caryn Anderson

Navigating the road to homeownership can put you on a confusing path. With so many different options out there, it’s tough to keep them all straight. Finding the right mortgage for you can be similar to finding the right home. You need to take a good look at the outside and then examine the structure for any hidden surprises that could cost you down the line.

If you find yourself wondering what a conforming loan is and if you qualify, you’re not alone. Read on to learn more about the difference between conforming and non-conforming loans and discover some of the pros and cons of each of these loan types.

Conforming Loan

As its name implies, a conforming loan conforms to specific guidelines. Freddie Mac and Fannie Mae, two financial entities created by Congress that operate under the umbrella of the Federal Housing Finance Agency (FHFA), issue these guidelines. Freddie Mac and Fannie Mae provide stability in the housing market, and in addition they give access to funds to the banks and mortgage companies that issue loans that meet Fannie Mae and Freddie Mac’s lending criteria.

What Is a Conforming Loan?

Conforming loans meet strict underwriting rules and stay within the limits established by Freddie Mac and Fannie Mae. This makes these loans lower risk, which translates to lower mortgage rates and terms that are more favorable for borrowers.

Is a Conforming Loan the Same as a Conventional One?

Many borrowers confuse conforming mortgages with conventional mortgages. Conventional mortgages include all home loans that aren’t backed by the United States Government. Conforming mortgages meet specific criteria that make them eligible for purchase by Fannie Mae and Freddie Mac. Conventional loans can include conforming mortgages, but they exclude any loans made or backed by the Federal Housing Administration (FHA), the Veterans Administration (VA) or the United States Department of Agriculture.

Conforming Loan Limits

The limit for conforming loans has changed over the years, beginning with the initial conforming loan limit of $33,000 when the Emergency Home Finance Act of 1970 first created a limit for conforming loans. That limit rose to $60,000 in 1977 and $67,500 in 1979. The FHFA determines this limit based on data about home pricing from October of the previous year to October of the current year. When the FHFA changes the limit, the agency announces it in November and the changes become effective the following January. As of July 2016, conforming loans have a limit of $417,000 for single-unit homes. In specific high-cost housing markets, the FHFA allows higher limits for conforming loans.

High-cost limits for areas with high costs of living and expensive housing markets are set at 115% of the area’s median home value, up to $625,500. These larger loans are often called conforming jumbo loans. The following table illustrates the 2016 standard limits:

Number of Dwellings in the Home Contiguous States, District of Columbia and Puerto Rico Alaska, Guam, Hawaii and the U.S. Virgin Islands
1 $417,000 $625,500
2 $533,850 $800,775
3 $645,300 $967,950
4 $801,950 $1,202,925

To see how the limits change for high-cost areas, consider the table below:

Number of Dwellings in the Home Contiguous States, District of Columbia and Puerto Rico Alaska, Guam, Hawaii and the U.S. Virgin Islands
1 $625,500 $938,250
2 $800,775 $1,201,150
3 $967,950 $1,451,925
4 $1,202,925 $1,804,375

Non-Conforming Loan

Non-conforming loans include all of those that don’t meet the Freddie Mac and Fannie Mae criteria. For example, if you’re buying a single-family home that isn’t located in a high-cost area and you need a mortgage for $550,000, you would not be eligible for a conforming loan, which limits borrowers to $417,000. Other reasons that a borrower might not meet the lending guidelines for a conforming loan include the following:

>If a borrower has a credit score below 620 or a problematic credit history

>If the borrower cannot provide necessary documentation of employment history, income level and assets

>If the borrower has a debt-to-income ratio that exceeds 45%

>If the borrower claimed bankruptcy within the past two years

>If the borrower has a very high level of debt

Additionally, borrowers asking to borrow more than 90% of the home’s purchase price typically don’t qualify for conforming loans. For borrowers who need a “jumbo” loan that exceeds $417,000, or those who fail to meet the criteria for any of the above reasons, a non-conforming loan may be the only option.

While these loans offer borrowers an option, they also come with a price. Because lenders see non-conforming loans as a risky investment, they may charge high interest rates.

Non-Conforming Loan Limits

While conforming loans have set limits, non-conforming loans don’t. These loans can be more difficult to obtain, although this depends on your financial status, but they work well for higher priced properties. Depending on the lender you select, you can choose from fixed rate or adjustable rate options. In most cases, you have to make a 20% down payment on the home to offset the increased risk associated with these loans.

Conclusion

When it’s all said and done, you need to get the type of loan that works well for you. Conforming loans are more ideal than non-conforming loans. Because lenders can freely sell this type of loan to free up capital, they like making these loans and see them as less risky. This translates to lower interest rates and other fees for borrowers. For borrowers who don’t qualify, a loan with the Federal Housing Administration could be another option with lower fees. If all else fails, a non-conforming loan can secure your path to homeownership.

Before you sign on the dotted line, research all your options. Check your credit report to know where you and your credit score stand. Whether you opt for a conforming or a non-conforming loan, compare rates with several lenders to make sure you get the most competitive option available.

You can trust that we maintain strict editorial integrity in our writing and assessments; however, we receive compensation when you click on links to products from our partners and get approved.
Published August 11, 2016 Updated: September 8, 2016
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