Conforming
If you have ever applied for a mortgage, you may have heard lenders refer to loans and wonder what is the difference between conforming vs conventional loans?
But if you are a mortgage lender, you are fully aware that referring to a loan and know the differences between conforming vs conventional, knowing doesn’t always mean the same thing.
A lot of confusion around conforming mortgages stems from the fact that only conventional can be conforming. However, not all conventional (as you will soon see) are conforming mortgages.
So, what makes a loan conventional and what makes it conforming? Can a conventional be conforming?
Below we will discuss the differences between conforming vs conventional mortgages.
What Is A Conforming Loan?
Since the financial crisis of 2008, most consumers are familiar with the names Fannie Mae and Freddie Mac. These two quasi-government entities are mortgage aggregators that were placed into conservatorship under the oversight of the Federal Housing Finance Agency (FHFA).
Fannie Mae and Freddie Mac have deep roots within housing and financial markets and serve the purpose of purchasing mortgages, packaging them into mortgage-backed securities, and selling those mortgages to investors.
A conforming mortgage refers to a mortgage that meets Fannie Mae and/or Freddie Mac’s purchase requirements.
Most lenders sell conforming mortgages to the secondary market. The sale usually happens a few months after the closing. Lenders may even take up to two months of escrows to cover this transition. Lenders choose to sell off these loans to increase liquidity, similar to that of a revolving line of credit.
However, just because a loan is sold doesn’t always mean the servicing of it necessarily changes. Lenders can receive income for administering and servicing the debt, often referred to as servicing rights.
An example of servicing responsibilities includes, but are not limited to, collecting monthly payments, maintaining escrows (where applicable), as well as providing information, notices, a copy of the note, and disclosures to the borrowers.
Types of Conforming Loans
Conforming loans are called conforming because they conform to Fannie Mae and Freddie Mac guidelines. Once a conventional has met this standard, then the conventional loan is now conforming. Not every conventional thought is conforming, as these loans may not meet the Fannie Mae or Freddie Mac standard.
A conforming mortgage can be offered as either a fixed-rate or an adjustable-rate. Adjustable-rate mortgages are also referred to as variable-rate mortgages.
Fixed-rate mortgages inherently have an interest rate that is constant, meaning it doesn’t change over the life of the loan.
Adjustable-rate mortgages (ARMs) on the other hand may have an initial period where the rate is fixed, but after a certain point the repayment terms allow for the interest rate to adjust (either up or down, with certain periodic and lifetime caps) on a predetermined schedule. Please see your note for details, if applicable.
The increase or decrease is based on an index plus a set margin. The index used for ARM rates is now:
Secured Overnight Financing Rate or SOFR
The Previous indices used were:
London Interbank Offer Rate (LIBOR)
11th District Cost of Funds (COFI)
Moving Treasury Average (MTA)
Fixed-rate mortgages are often advantageous for borrowers looking for a more stable or predictable monthly payment.
On the other hand, adjustable-rate mortgages can sometimes offer more favorable rates in the short term, benefiting those borrowers who are looking to pay off their mortgage within a specific time horizon.
Either option can be utilized for a purchase or refinance (both rate-term or cash out) transaction.
What is a Non-Conforming Loan?
While conventional mortgages can certainly be conforming, they do not always meet the conforming criteria outlined by Fannie Mae and Freddie Mac. Thus, conventional mortgages can also be non-conforming mortgages.
The two main reasons why a mortgage may be considered non-conforming is that it can either be purchased by another entity or the loan does not fall within the standard conforming limits.
Types Of Non-Conforming Loans
The two best examples of non-conforming mortgage loans are government-backed loans and jumbo mortgage loans.
As the name suggests, government-backed loans are loans that are insured by the federal government in some capacity.
In most cases, these loans are insured up to a certain threshold, protecting the lender in the event a borrower defaults on the debt. This lowers the risk of the lender who can then offer more favorable repayment terms to the borrower(s).
A few examples of government-backed mortgage loan programs are FHA, USDA, and VA loan programs. Many of these offer lower down payment requirements and more flexible underwriting criteria.
Jumbo’s are non-conforming mortgages that exceed the loan limit set by the FHFA, based on a variety of factors, that make them ineligible for purchase by Fannie Mae and Freddie Mac.
Since the jumbo’s usually carry higher loan amounts (as the name entails), they are often seen as carrying more risk compared to conforming counterparts. This usually means that certain lenders may require more rigorous credit standards and eligibility criteria.
Note that both government-backed and jumbo mortgages can both be offered as fixed-rate or adjustable-rate mortgages. However, because they do not meet the purchase criteria of either Fannie Mae or Freddie Mac, they wouldn’t be considered a conforming loan.
Comparing Conforming Vs Non-Conforming Options: Pros and Cons
If you are in the market for a new mortgage figuring out whether to go with a conforming or non-conforming option can be a bit tricky.
Thankfully, New Century Mortgage has been able to help borrowers just like you weigh the pros and cons of multiple mortgage financing options, outline key benefits that align with your particular end-goals.
Benefits of Conforming Loans
Conforming mortgages certainly have some benefits over their non-conforming counterparts.
For starters, conforming mortgages have fairly standard qualification requirements. While Fannie Mae and Freddie Mac are two separate entities, their underwriting criteria and eligibility requirements align very closely.
While individual lenders may have additional underwriting overlays, in general most conforming loans require similar criteria for approval. This also simplifies the comparison process if borrowers want to shop lenders to find the best rate and repayment terms.
Additionally, conforming conventional loans are probably the most widely offered solution that consumers can take advantage of. This is partially due to the fact that these loans carry less risk, as they are being sold off into the secondary market as opposed to remaining on the lender’s books.
Since there are a multitude of lenders that offer conforming conventional mortgages, consumers have more choices on who they want to do business with.
Lastly, while it is not always the case, in general conforming mortgages can often offer a lower interest rate compared to other non-conforming options.
Benefits of Non-Conforming Loans
Non-conforming mortgages can be ideal programs for clients, some may even offer lower rates than conforming. The only difference is the programs simply don’t meet the requirements to be a conforming mortgage, another words these loans do not ‘conform’ to the standards set out by Fannie and Freddie.
In fact, there are several benefits to going with a non-conforming mortgage solution. In some cases that might be your only option.
Generally, government-backed non-conforming loans can offer lower down payment requirements compared to conforming conventional loans.
Some solutions may even waive a down payment altogether for borrowers who meet certain eligibility criteria. Most jumbo mortgage providers will generally require a down payment.
However, jumbo mortgage options allow borrowers the flexibility of taking out a larger loan amount outside the conforming loan thresholds, assuming the applicant can carry the debt. This can be beneficial for those transactions where the subject is a more expensive or unique piece of real estate.
Unlike conforming mortgages, non-conforming mortgage solutions are less restrictive with the types of real property being used as collateral. The same is true with respect to qualifying credit requirements, making non-conforming mortgage solutions much more individualized and flexible.
What is Needed for a Conventional Loan?
There are a number of different requirements when it comes to taking out a conventional loan, including the following:
Down Payment
The requirement for a down payment will differ from person to person depending on such criteria as credit score, type of property, loan amount, if it is primary, 2nd home or investment and the sort of subject or loan you are getting.
For instance, if you are making no more than 80 percent of the median income in your location, you might qualify for Home Ready or Home Possible. There are other mortgage programs that could require a set minimum or even no down payment requirement such as VA and USDA. However, you will still need enough money for closing costs and possibly other expenditures.
If the property you are purchasing is not a single-family home, i.e. it has more than one unit or if it is a second home or investment property you may need to have a larger down payment depending on the program.
Jumbos generally up to $3,000,000 might be accessible through top lenders, however the larger the loan amount, the harder it may prove to qualify. Mortgages above $3,000,000 may require more documentation and reserves depending on the scenario. A larger loan amount may require a larger down payment as well, so please make sure to inquire to see what documentation might be needed and other items to properly set your expectations.