What is a Conforming Loan?

What you need to know before you get a mortgage

When you decide to buy a home, there’s a good chance you’ll hear the term “conforming loan.” Understanding that term is an important part of making sure you make the right choice for you when it comes to buying a home.

Basically, a conforming loan is one that meets a limit set by the Federal Housing Finance Agency (FHFA). A loan that meets these conditions allows Fannie Mae and Freddie Mac to buy your mortgage from the lender.

Not every conforming loan is bought by Fannie or Freddie, but most loans made in the U.S. are helped, in some way, through those entities. Fannie and Freddie purchase and securitize new mortgages that meet their criteria. In fact, between 2018 and 2028, the Congressional Budget Office expects these two entities to guarantee $12 trillion in new mortgage-backed securities.

2019 Conforming Loan Limits

For 2019, FHFA announced an increase to $484,350, up from $453,100 in 2018. As long as your loan is under that amount, it’s a conforming loan.

Limits are set based on an annual survey that takes into account the increase or decrease in average housing prices. As prices rise, the conforming loan limit does, too, so housing remains attainable for middle- and lower-income buyers.

How a Conforming Loan Works

In short, a lender makes a loan that meets guidelines set forth by the FHFA. They know that Fannie Mae or Freddie Mac will potentially buy the loan later, so they’re willing to lend.

The biggest feature of the conforming loan is the limit. In order to meet requirements, the FHFA limits the size of the loan—also reducing the risk of a default. Anything that is larger than the conforming limit is considered a jumbo loan.

However, even though the conforming loan limit is the item that receives the most attention, conforming loans also have other underwriting criteria.

For example, Fannie Mae has rules for lenders that take into account loan-to-value ratio, debt-to-income, and credit score. Lenders look at the rules set by Fannie and Freddie and then create a conforming loan it can sell later. You can buy with as little as a 3% down payment, as long as you meet credit score requirements and pay mortgage insurance.

By selling mortgages to Fannie and Freddie, the lender can get them off their own balance sheets, freeing up more capital to make more loans. The idea is to help the mortgage market remain somewhat affordable and stable.

Pros and Cons of Conforming Loans

As with most financial decisions, there are pros and cons associated with conforming loans. Carefully consider what you’re getting into so you can make the best choice for you.

Benefits

• Can be easier to qualify for

• In many cases, you get a lower interest rate

• Might be able to make a smaller down payment

• There’s some flexibility with your credit score

Downsides

• Limited to a specific loan amount

• Can’t buy certain types of property

• Negative credit events, such as foreclosure or bankruptcy, might prevent you from getting a loan

• It’s harder to get a conforming loan if your FICO score is below 620

Bottom Line

For many homebuyers, a conforming loan makes sense. As long as you’re within the loan limit and meet the basic underwriting criteria, these loans are relatively easy to qualify for, and they often provide you with the best interest rate as long as you meet credit requirements.

Original article published by TheBalance.com

Written By: MIRANDA MARQUIT