Conforming Loan: What It Is, How It Works, vs. Conventional Loan

What Is a Conforming Loan?

A conforming loan is a mortgage that meets the dollar limits set by the Federal Housing Finance Agency (FHFA) and the funding criteria of Freddie Mac and Fannie Mae. For borrowers with excellent credit, conforming loans are advantageous due to their low interest rates.

How a Conforming Loan Works

The Federal National Mortgage Association (FNMA, or Fannie Mae) and the 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 (single-family dwellings) must conform if eligible for the agencies’ backing.

Fannie Mae and Freddie Mac do not issue mortgages themselves. Instead, they insure mortgages issued by lenders, such as banks, and act as secondary market makers if lenders wish to sell those mortgages.

Loan Limits and Rules

The term “conforming” is often used to describe the mortgage amount, under a certain dollar figure, or loan limit, set each year by the FHFA.

For 2023, this baseline limit is $726,200 for most of the United States. In some high-cost markets, such as San Francisco and New York City, the limit is higher. The 2023 ceiling for these areas is $1,089,300, or 150% of $726,200.

Special statutory provisions establish different loan limits for Alaska, Hawaii, Guam, and the U.S. Virgin Islands, where the baseline loan limit is also $1,089,300 for one-unit properties in 2023.

Besides the size of the loan, other guidelines to which conforming loans must adhere include the borrower’s loan-to-value (LTV) ratio, debt-to-income ratio, credit score and history, and documentation requirements.

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, the buyer who makes a low down payment may be required to purchase mortgage insurance, the cost of which varies according to their loan’s terms. For example, for 30-year loans of $625,500 or less, with an LTV ratio greater than 95%, the cost is about 0.85% of the loan amount per year.

Lenders also prefer to work with conforming loans, which can be packaged quickly into investment bundles and sold in the secondary mortgage market. This process frees up a financial institution’s capacity to issue more loans, which is how it makes money.

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 for the secondary market, the demand for nonconforming loans is much less.

The terms and conditions of nonconforming mortgages can vary widely from lender to lender. Still, the interest rate and minimum down payment are typically higher because these loans carry greater risk for a lender. Not only is more money involved, but the loan cannot be guaranteed by government-sponsored entities.

Conforming Loans vs. Conventional Loans

Conforming loans are sometimes confused with conventional loans/mortgages. Although the two types overlap, they are not the same thing. 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 whether a mortgage is conventional. In effect, all conforming loans are conventional, but not all conventional loans qualify as conforming.

FHFA Regulations

The FHFA has regulatory oversight to ensure Fannie Mae and Freddie Mac fulfill their charters and missions of promoting homeownership for lower-income and middle-class Americans.

Under the mandate of the Housing and Economic Recovery Act (HERA) of 2008, the conforming loan limit is adjusted annually to reflect changes in the average home price in the United States. The annual limit is set by Fannie Mae’s and Freddie Mac’s federal regulator, the FHFA, and announced in November for the following year. The FHFA uses the October-to-October percentage increase/decrease in the average house price, as indicated in the House Price Index report, to adjust the conforming loan limit for the subsequent year.

Because the FHFA uses the House Price Index to determine the following year’s loan limits, the annual increases in loan limits are pretty automatic. Each time home prices rise, the FHFA increases the mortgage limits.

The Bottom Line

A conforming mortgage loan meets the dollar limits set by the Federal Housing Finance Agency (FHFA) and the funding criteria of Freddie Mac and Fannie Mae. These agencies have standardized rules to which mortgages for single-family dwellings must conform. Mortgages that exceed the conforming loan limit are classified as nonconforming or jumbo mortgages.