What Is a Conforming Loan? And How Do They Work?

Written by Elijah BishopReviewed by Nathan Brown, CFP®Updated: 29th Apr 2022
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Are you in the market for a new loan? When shopping for a new loan, it is common for you to come across specific mortgage terms.

One of such terms you will read and hear is the term Conforming Loan. Conforming loans is the go-to loan option for most home buyers with excellent credit scores and enough cash for a down payment.

But if you’re a home buyer looking to finance the purchase of a more expensive home, then a conforming loan may not be your best option.

Read on to learn more about conforming loans, how they work, and why you should or shouldn’t use one.

What is Conforming Loan?

A conforming loan is a loan that abides by the rules and regulations set by Fannie Mae and Freddie Mac, the government-sponsored enterprises that purchase mortgage loans.

Such rules and regulations typically include loan qualification, loan terms, minimum credit score, and the maximum loan limits.

>> More: What Government Home Loans Are Available?

How Do Conforming Loans Work?

For any loan to be considered a conforming loan, its loan amount must meet the Federal Housing Finance Agency (FHFA).

When we say conforming loan limit, we mean the maximum amount you can borrow since Freddie Mac and Fannie Mae cannot legally purchase loans beyond the approved FHFA loan limits.

While conforming loans are common across borrowers and widely available from mortgage lenders, they are not insured or backed by the federal government. And as such, they are a type of conventional loan.

>> More: Best Online Mortgage Lenders

Conforming Loan Limits

The conforming loan limit set by the FHFA for 2021 are $548,250 for a single-family home in most areas in the US.

However, it is still possible to borrow as high as $822,375 in places with high home value, such as New York, Hawaii, and California. You can easily check the specific conforming loan limit for any county using the FHFA map.

More importantly, the FHFA reviews the conforming loan limits of each area annually to keep it in line with the changes in the national average home prices.

For instance, between 2019 and 2020, the loan limit increased by only 5% to reflect the annual changes in the housing price index.

Conforming Loan Requirements

Since mortgages have to meet certain standards to be eligible for purchase by Fannie Mae and Freddie Mac, there are also several requirements borrowers must meet to qualify for one.

These requirements include:

VariablesRequirements
Loan Limits (Single-Family Home):$548,250 in most areas; up to $822,375 in high-cost areas
Credit Score Minimum:620
Debt-to-Income Maximum:45%
Down Payment Minimum:3%
Loan-to-Value Maximum:97%

When applying for a conforming loan, if you’re near or above any of the limits, you will generally have to make up for it in another section.

Also, individual lenders may decide to set up their additional requirements. So, you must shop around lenders to find the best offer.

Advantages and Disadvantages of Conforming Loans

Before applying for a conforming loan, you must consider its advantages and disadvantages.

Here are some of the advantages and disadvantages of conforming loans:

Advantages

  • Easier qualification. It is typical for conforming loans to have low-down-payment and credit score requirements when compared to non-conforming loans.
  • Lower Interest Rates. Since conforming loans are monitored by the FHFA, it is common for lenders to offer some of the best rates compared to non-conforming or other loan options.
  • If you make a down payment of at least 20%, you won’t need to pay for private mortgage insurance, which can save you a considerable amount of money monthly.

Disadvantages

  • Your DTI ratio must meet the specified conforming loan standard. Under conforming loan, the maximum DTI ratio is typically 36% but can go as high as 50% if you have an excellent credit score or down payment
  • Your dream home could be priced above the conforming loan limit in your county, especially if you’re in a higher-priced market.

How Are Conforming Loans and Conventional Loans Different?

For most first-time homebuyers, there is always confusion between conforming loans and conventional loans.

While they seem to share certain similarities, these two terms cannot be used interchangeably.

  • A conforming loan is a conventional loan that conforms to the GSE’s guidelines (loan limits, downpayment, and loan amount). All conforming loans are conventional loans, but not all conventional loans (Jumbo loans) are conforming loans.
  • A conventional loan is simply a loan that isn’t backed by the federal government (FHA, VA, USDA). A conventional loan can either be conforming or non-conforming.

Understanding Conforming and Non-Conforming Loan Differences

  • A conforming loan is a loan that conforms to the guidelines set by Fannie Mae and Freddie Mac regarding a borrower’s credit score requirement, loan limit, down payment, and other loan requirements.
  • A non-conforming loan does not adhere to the rules and regulations set by government-backed enterprises. For example, jumbo loans and FHA loans are considered non-conforming because their loan limit and loan requirements do not conform to Fannie Mae and Freddie Mac’s rules. Remember that just like conforming loans, non-conforming loans also has its advantages and disadvantages.

>> More: Conforming vs. Non-Conforming Loans

What Are the Fees and Costs Associated with Conforming Loans?

Based on the rules and regulations guiding conforming loans, you may be required to carry private mortgage insuranceif your down payment is lower than 20%.

So, if a home was valued at $100,000, unless you are putting down $20,000 or more, you may have to pay for PMI. You may also have to pay origination fees.

The amount you pay for origination fees is typically determined by your lender and not Fannie Mae or Freddie Mac. That is why you should shop around to find the best fees and loan terms.

How to Apply for a Conforming Loan

When applying for a conforming loan, there are several steps you must take to ensure that you get the best conforming loan rate and terms.

Check Your Credit Score

Before applying for a conforming loan, you should consider checking your credit score on AnnualCreditReport.

You should check your credit report at least three months before applying. When checking your credit report, you should check for any factual errors and out-of-date items.

Checking your credit score early can help you identify and dispute any mistakes.

Prepare Your Documents

Getting a conforming loan comes with scrutiny of your finances and employment records. In addition to your credit report, you may want to have documents like payroll stubs, W-2 forms, bank statements, retirement account, and your last two tax returns.

Get Pre-Approved

Once you find your desired local lender, the next step is to get pre-approved for a mortgage.

Getting pre-approved can help you speed up the home buying journey and uncover any issues with your documents.

More importantly, getting pre-approved can prove to home sellers and real estate agents that you are a serious buyer, giving you an edge in a multiple offer situation.

Avoid Additional Credit

It is common for lenders to check and re-check a borrower’s credit report, bank statements, and financial records during mortgage processing until the closing date.

To avoid any unplanned surprise, you may want to avoid taking on additional credit such as a new credit card or personal loan.

Is a Conforming Loan Good?

While conforming loan limits may seem like a downside, especially if you live or are buying in a high-value market, there are still several upsides to getting a conforming loan.

Not only are you applying to a loan with limits that the FHA has deemed safe, but you are more likely to get the best loan terms with a conforming loan.

A conforming loan can offer you a great deal when you have a low debt ratio, excellent credit score, and the necessary financial documentation.

However, just like any other loan program or option, you should consider shopping around to get the best terms possible.

What Is the Difference Between FHA and Conforming Loans?

If you are searching for the right mortgage to finance your home purchase, you’re bound to choose between FHA loans and conforming loans.

In this section, we’ll discuss some of the differences between these two loan types.

VariablesFHA LoanConforming Loan
Down Payment:FHA loan requires a down payment of 3.5%, no matter your property type.In contrast, conforming loans has varying down payment requirements. On average, GSEs allow a minimum down payment of 5% on a single-family home, and the minimum can rise to 25% for 3-4 units.
Mortgage Insurance Premium (MIP):FHA charges two types of MIP ─ upfront mortgage insurance premium and an annual mortgage insurance premiumConforming loan charges zero upfront mortgage insurance and annual private mortgage insurance. In addition, conforming loans only require PMI for loans for which the LTVs exceed 80%.
Mortgage Rates:Mortgage rates for FHA loans are based on Ginnie Mae mortgage bonds Conforming loans, on the other hand, are based on mortgage bonds insured by Fannie Mae and Freddie Mac

When deciding on which of the above loan option to go for, you should consider discussing your choice with your loan officer for proper guidance.

Bottom Line: What Is a Conforming Loan?

Conforming loans follow specific guidelines set by Fannie Mae and Freddie Mac. While conforming loan guidelines may appear as a challenge, conforming loans are often an excellent option for the average homebuyer.

Depending on your mortgage and housing goals, a conforming loan may be all you need to make your housing dream come through.

Elijah Bishop
Elijah Bishop

Elijah A. Bishop is a Senior Personal Finance Writer who has been writing about real estate and mortgages for years. He has a Bachelors of Arts Degree in Creative writing from Georgia State University and has also attended the Climer School of Real Estate. He also holds a realtor license and has been in and out of the US mortgage industry as a loan officer. Bringing over 15 years of experience, Elijah produces content that analyzes ethnicities, race, and financial well-being. His areas of expertise are mortgages, real estate, and personal loans.