Conforming Loan

What is 'Conforming Loan'

A conforming loan is a mortgage that is equal to or less than the dollar amount established by the conforming loan limit set by The Federal Housing Finance Agency (FHFA) and meets the funding criteria of Freddie Mac and Fannie Mae.

For borrowers with excellent credit, conforming loans are advantageous due to the low interest rates affixed to the loans.

BREAKING DOWN 'Conforming Loan'

A conforming loan is a mortgage that is eligible for purchase by the Federal National Mortgage Association (FNMA or Fannie Mae) and Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac), government-sponsored entities that drive the market for home loans. The quasi-governmental agencies created standardized rules and guidelines that mortgages must conform to in order to be a conforming loan. The term "conforming" is most often used when speaking specifically about the mortgage amount which must fall under a certain limit, known as the conforming loan limit, set by the Federal Housing Finance Agency (FHFA). For 2018, this limit is $453,100, an increase from $424,100 in 2017. In high-cost markets the limit is higher. The new ceiling loan limit for one-unit properties in most high-cost areas, such as San Francisco and New York City, is $679,650 — or 150 percent of $453,100. The Housing and Economic Recovery Act (HERA) requires that the baseline conforming loan limit be adjusted each year for Fannie Mae and Freddie Mac to reflect the change in the average U.S. home price.

Other than the size of the loan, other guidelines conforming loans adhere to include borrower's loan-to-value ratio (i.e. the size of down payment), debt-to-income ratio, credit score and history, documentation requirements, etc. For example, a conforming loan through Fannie or Freddie can have a down payment as low as 3 percent and the borrower must be a first-time homebuyer. In addition, private mortgage insurance (PMI) of about 1.05 percent per year for 30-year loans up to $453,100 is required on the loan. Part or all of the cost of the insurance is tax-deductible if the borrower’s household adjusted gross income (AGI) is no more than $109,000.

The FHFA, which sets the conforming loan limit on an annual basis, has regulatory oversight to ensure that Fannie Mae and Freddie Mac fulfill their charters and missions of promoting homeownership for lower income and middle class Americans. FHFA uses the October to October percentage increase/decrease in average housing prices in the Monthly Interest Rate Survey (MIRS) to adjust the conforming loan limits for the subsequent year. To conduct this survey, FHFA asks a sample of mortgage lenders to report the terms and conditions on all single-family, fully amortized, purchase-money, nonfarm loans that they close during the last five business days of the month.  The survey provides monthly information on interest rates, loan terms, and house prices by property type, by loan type (fixed- or adjustable-rate), and by lender type, as well as information on 15-year and 30-year fixed-rate loans.

It is important to note that Fannie Mae and Freddie Mac do not issue mortgages; instead, they insure mortgages issued by lenders, creating more room for banks to issue more loans than they would have otherwise been able to do without the insurance. For this reason, lenders prefer to work with conforming loans as they can be easily packaged into investment bundles and sold in the secondary mortgage market, freeing up capacity to lend more to home buyers.

Both Fannie Mae and Freddie Mac only buy loans that are conforming to repackage into the secondary market, making the demand for a nonconforming loan much less. Mortgages that exceed the conforming loan limit are classified as nonconforming or jumbo mortgages. The terms and conditions of nonconforming mortgages can vary widely from lender to lender, but the mortgage rates and minimum down payment for jumbo loans are typically higher because they carry greater risk for a lender.