A Conventional Loan Conforms to Guidelines Set By GSEs Like Fannie Mae and Freddie Mac

Buying a home is an exciting yet challenging process. As a homebuyer, you have to make one of the biggest financial decisions of your life – choosing the right mortgage loan. While there are many loan options to pick from, conventional loans remain one of the most popular choices for home buyers But what exactly is a conventional loan and how does it work?

What is a Conventional Loan?

A conventional loan is simply a mortgage loan that is not insured or guaranteed by the federal government. Instead, it is backed by private lenders like banks, credit unions, mortgage companies and other financial institutions.

Conventional loans come in two main types

• Conforming loans – These adhere to guidelines set by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac Conforming loans have loan limits that are set each year by the Federal Housing Finance Agency (FHFA)

• Non-conforming loans – These don’t conform to the standards set by the GSEs. Common examples are jumbo loans that exceed the conforming loan limits.

Conforming Conventional Loans Explained

Conforming conventional loans make up the majority of mortgages in the US. They are a preferred choice for many homebuyers because they offer stable interest rates and greater flexibility.

But what exactly does it mean when a conventional loan “conforms to guidelines”?

Basically, conforming loans have to meet certain requirements set by Fannie Mae and Freddie Mac in order to be purchased by the GSEs on the secondary mortgage market. These guidelines relate to:

• Loan amounts – There are maximum loan limits that determine if a loan is conforming or not. In 2023, the baseline conforming loan limit for a single-family home is $726,200. However, it can go up to $1,089,300 in certain high-cost regions.

• Credit standards – To qualify for a conforming loan, you’ll typically need a minimum credit score of 620, a debt-to-income ratio below 50% and a down payment of at least 3-5%. Stronger credit scores may qualify you for better terms.

• Loan features – Conforming loans can’t have risky features like interest-only payments or negative amortization. There are also limits on points and fees charged.

• Property types – Conforming loans can only be used to finance single-family homes with 1-4 units. This includes primary residences, second homes and investment properties.

• Occupancy status – Conforming conventional loans can be used for primary residences, second homes as well as non-owner occupied investment properties.

• Ability to repay – Lenders have to make sure borrowers have the ability to repay the mortgage before approving a conforming loan. Several factors are considered like income, assets, employment and credit history.

• Disclosures – Lenders have to provide proper disclosures to borrowers at various stages of the mortgage process. This includes details about loan costs, terms, risks etc.

By setting such standards, the GSEs aim to encourage responsible lending practices. Loans that are too risky don’t conform and can’t be purchased by Fannie Mae or Freddie Mac.

Why Choose a Conforming Loan?

Conforming conventional loans offer home buyers several benefits:

• Stable rates – Because they are backed by the GSEs, conforming loans tend to have lower and more stable interest rates compared to non-conforming mortgages.

• Lower down payment – Conforming loans allow down payments as low as 3% with mortgage insurance. This makes them more affordable than other loan types that require 10-20% down.

• Flexible terms – Borrowers can choose from a range of term lengths from 10-30 years. Options for fixed and adjustable rates are also available.

• No prepayment penalties – Conforming loans let you pay off your mortgage early or refinance whenever needed without any penalty fees.

• Easier to qualify – Thanks to standardized eligibility criteria, qualifying for a conforming loan is simpler compared to non-conforming alternative mortgages.

• Purchase by GSEs – The fact that conforming loans can be purchased by Fannie Mae and Freddie Mac provides added liquidity and stability for lenders. This gets passed on to the borrower.

• Consumer protections – Strict conforming loan rules prevent deceptive and predatory lending practices. Mandatory disclosures also create transparency.

Conforming Loan Limit Changes for 2023

The baseline conforming loan limit is adjusted annually based on changes in home prices. For 2023, the FHFA has raised the baseline conforming loan limit from $647,200 to $726,200 – an increase of around 12.2%.

Higher limits up to $1,089,300 are also now available for certain high-cost areas like San Francisco, New York, Los Angeles etc. These updated limits allow more home buyers to take advantage of conventional financing.

According to the FHFA, higher limits will help maintain liquidity and expand access to credit in the housing market. Over 99% of US counties have seen median home prices rise above the old 2022 baseline limit of $647,200.

The Bottom Line

Conforming conventional loans remain the most common mortgage option due to their relative stability and affordability for mainstream home buyers. Their guidelines are set by the GSEs – Fannie Mae and Freddie Mac. So when you take out a conforming loan, you can be assured that it meets certain prudential standards set by the FHFA and GSEs. This makes them less risky than non-conforming alternative mortgages. Conforming loan limits are also adjusted periodically based on housing data to keep them relevant. If you’re shopping for a mortgage, conforming conventional loans are worth considering.