Is a Conforming Loan a Conventional Loan? Understanding the Difference

Many homebuyers looking to finance their dream home find themselves confused by mortgage terminology like “conforming loans” and “conventional loans”. With overlapping definitions, it’s easy to assume these terms can be used interchangeably. However, there are some key differences between conforming and conventional loans that buyers should understand before applying for financing.

Conventional Loans: The Basics

A conventional loan is a mortgage not backed by the federal government. This means conventional mortgages are issued by private banks and lenders instead of government agencies like FHA, VA, or USDA.

Conventional loans make up the majority of mortgages issued in the U.S. According to census data, around 75% of home purchases are financed through conventional lending.

Because they are privately issued, conventional lenders have more flexibility in setting their own borrowing criteria and loan terms compared to government programs. They generally base approval on factors like your credit score, income, assets, and debts.

Within the scope of federal regulations, conventional lenders can set their own interest rates and fees. This allows them to remain competitive and offer rates that respond to market conditions.

What Makes a Loan Conforming?

While conventional loans are defined by their private origins conforming loans are defined by the standards set for purchase by Fannie Mae and Freddie Mac. These two government-sponsored enterprises (GSEs) buy mortgage loans from lenders to provide liquidity and free up capital for new lending.

Fannie and Freddie package the loans they buy into mortgage-backed securities. This gives investors opportunity to essentially invest in mortgages The securities are then traded publicly like bonds and stocks.

For a conventional loan to be eligible for purchase by Fannie or Freddie, it must meet certain conforming loan requirements published each year by the Federal Housing Finance Agency (FHFA).

Here are the current conforming loan standards for 2023:

• Minimum credit score of 620
• Maximum debt-to-income ratio of 45% (or 50% with exceptions)
• Loan amounts below conforming loan limits based on location
• Minimum down payment of 3% (with private mortgage insurance if under 20%)

Meeting these conforming criteria allows conventional loans to be sold to Fannie and Freddie. This provides lenders with funds to issue new mortgages.

• All conforming loans are conventional
• But not all conventional loans conform to agency standards

Conforming Loan Limits

A key factor that determines if a conventional loan is conforming or not is whether it exceeds the conforming loan limit set annually by the FHFA.

For 2023, the baseline conforming loan limit for most of the U.S. is $726,000 for single family homes. Higher limits up to around $1,089,000 apply in more expensive real estate markets like New York or San Francisco.

If a conventional loan exceeds the conforming loan limit for its area, it cannot be purchased by Fannie or Freddie. In that case, it would be considered a non-conforming or “jumbo” loan.

Jumbo loans typically come with stricter eligibility standards, higher interest rates, and larger down payments required by the private lender.

Benefits of Conforming Loans

Getting a conforming conventional loan has several advantages for borrowers compared to non-conforming options:

• Lower Interest Rates – Meeting agency standards means lenders can sell the loan to Fannie/Freddie, providing competitive rates.

• Lower Monthly Payments – The interest cost savings translates into lower principal and interest payments.

• No PMI Requirement – Borrowers with over 20% down can avoid private mortgage insurance.

• More Options – Conforming loans have wider availability through lenders of all sizes.

• Easier Qualifying Standards – Minimum 620 credit score and 45% DTI provides accessible options.

• Lower Fees – Origination fees and closing costs are typically lower compared to non-conforming mortgages.

When to Consider Non-Conforming Loans

Despite the advantages, conforming conventional loans aren’t right for every borrower or every real estate purchase. Here are some instances when non-conforming mortgages may be a better fit:

• Jumbo Loans – Needed to finance luxury homes or properties over conforming loan limits.

• Low Down Payment – FHA, VA, and USDA programs allow down payments under 3%.

• Lower Credit Requirements – Government programs may offer financing with credit scores below 620.

• Investment Properties – Conforming loans usually require higher down payments on non-owner properties.

• Unique Products – Non-conforming options like interest-only or adjustable rate mortgages meet specific needs.

Finding the Best Loan for You

As you navigate the home buying process, the most important thing is finding the right mortgage product for your financial situation. Here are some tips for choosing between conforming and non-conforming loans:

• Check your credit score and report – Know where you stand before applying.

• Research loan limits in your area – See if a conforming loan can work for your price range.

• Calculate your down payment – Conforming loans need as little as 3% down.

• Review your income/debts – Make sure you meet conforming DTI requirements.

• Compare offers from multiple lenders – See if conforming loans provide the best terms.

• Consider pre-approval – Get an idea of your chances before house hunting.

The end goal is securing favorable financing that fits your budget and needs. With a solid understanding of guidelines for conforming conventional loans, you can make an informed decision when applying for a mortgage. Consult with lenders to see if a conforming loan is the most advantageous option, or if a non-conforming alternative better suits your specific circumstances.