What Is a Conforming Loan?

A conforming loan is a mortgage that is equal to or less than the dollar amount established by the 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 them.

Key Takeaways

  • A conforming loan is a mortgage whose underlying terms and conditions meet the funding criteria of Fannie Mae and Freddie Mac—mainly, a dollar limit on the size of the loan.
  • The baseline conforming loan limit is adjusted annually. It is $548,250 in 2021 for most parts of the U.S.
  • Lenders prefer to deal with conforming loans, as these are the only type that Fannie Mae and Freddie Mac will guarantee and buy in the secondary mortgage market.
  • Conforming loans often offer more advantageous rates for borrowers.

How a Conforming Loan Works

The Federal National Mortgage Association (FNMA or Fannie Mae) and Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) are government-sponsored entities that drive the market for home loans. These quasi-governmental agencies have created standardized rules and guidelines to which mortgages for one-unit properties (aka single-family dwellings) must conform if they are to be eligible for the agencies' backing. (Fannie Mae and Freddie Mac do not issue mortgages themselves. Instead, they insure mortgages issued by lenders, and act as secondary market-makers if lenders wish to sell those mortgages.)

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 FHFA.

This baseline limit is $548,250 for most of the United States in 2021. That's an increase from $510,400 in 2020. In some high-cost markets, such as San Francisco and New York City, the limit is higher. The new ceiling for these areas is $822,375, or 150% of $548,250. Special statutory provisions establish different loan limit calculations for Alaska, Hawaii, Guam, and the U.S. Virgin Islands. In these areas, the baseline loan limit is $822,375 for one-unit properties in 2021.

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 the borrower’s loan-to-value ratio (i.e., the size of the down payment), debt-to-income ratio, credit score and history, documentation requirements, etc.

Advantages of Conforming Loans

For consumers, conforming loans are advantageous due to their low-interest rates. For first-time homebuyers taking out Federal Housing Administration (FHA) loans, for example, the down payment can be as low as 3.5%. However, mortgage insurance of about 0.85% per year for 30-year loans less than or equal to $625,000 is required on such loans when such a low down payment is made. 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 deduction is phased out entirely for taxpayers with an AGI above $109,000 (or $54,500 for married couples filing separately).

Lenders also prefer to work with conforming loans, as they can be easily packaged into investment bundles and sold in the secondary mortgage market. This process frees up a financial institution's capacity to issue more loans and lend more money to home buyers.

Conforming Loans vs. Nonconforming Loans

Mortgages that exceed the conforming loan limit are classified as nonconforming or jumbo mortgages. Because Fannie Mae and Freddie Mac only buy conforming loans to repackage into the secondary market, the demand for a nonconforming loan is much less. The terms and conditions of nonconforming mortgages can vary widely from lender to lender, but the interest rates and minimum down payment for jumbo loans are typically higher because they carry greater risk for a lender. Not only is more money involved, but the loan cannot be guaranteed by the government-sponsored enterprises.

Homebuyers in need of a mortgage in excess of the conforming-loan limits can get around the problem by taking out two smaller mortgages, instead of a single jumbo loan.

Conforming Loans vs. Conventional Loans

Conforming loans are often confused with conventional loans/mortgages. Although the two types overlap, they are not the same. A conventional mortgage is a much broader category. It is any loan offered through a private lender, as opposed to a government agency like the FHA or the U.S. Department of Veterans Affairs (VA), or backed by Fannie Mae or Freddie Mac, which is where any overlap—and confusion—arises.

The size of the loan doesn't affect its conventionality, only its conformality. In effect, while all conforming loans are conventional, not all conventional loans qualify as conforming.

Special Considerations for Conforming Loans

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. The 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 amortizing, purchase-money, non-farm 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, loan type (fixed rate or adjustable rate), and lender type, as well as information on 15-year and 30-year fixed-rate loans.