Conforming vs nonconforming loans: What’s the difference?

Conforming loan? Nonconforming loan? You might be baffled by these bits of mortgage jargon. Both can help you purchase the property you’re interested in, but there are important differences between the two, and if you’re in the market to secure a mortgage, it’s critical to have a solid grasp on them before you make a choice.

Below, we’ll go through the conforming vs nonconforming mortgage debate,  and help you figure out which one is right for you.

Differences between conforming and nonconforming loans

Conforming and nonconforming loans are popular types of home loans, but there are a few key differences between them.

For one, conforming loan sizes must fit within the loan limits determined each year by the Federal Housing Finance Agency (FHFA) and meet the underwriting guidelines set by the Dodd-Frank Act and the Consumer Finance Protection Bureau. Nonconforming loans don’t have either of these requirements. As a result, conforming loans can be sold to Fannie Mae and Freddie Mac,  but nonconforming loans can’t.

Another difference between conforming and nonconforming loans is that the former generally have lower interest rates, which reduces the cost of borrowing over the lifetime of the loan.

Conforming loans are the more common of the two.

What is a conforming loan?

A conforming loan is one that meets the guidelines set by the FHFA and other federal authorities, many of which were put into place following the subprime mortgage crisis in the mid-2000s. There are a number of criteria that must be met to qualify for a conforming loan, including the amount you’re borrowing.

Conforming loans exist so the government-sponsored enterprises (GSEs) Fannie and Freddie can buy them and automatically know that the mortgages they’re purchasing — and the borrowers who took them out — fit a set of standardized requirements and have met certain creditworthy criteria. 

Pros and cons of conforming loans

Pros

• Costs less: Because there is a larger secondary market for conforming loans, they often have lower interest rates than nonconforming loans — and that means lower monthly payments and less money spent over the life of the loan. Conforming loans also typically have lower down payment requirements.
• Fewer surprises in the application: The underwriting and approval process for conforming loans is highly standardized, so you’re unlikely to encounter unusual lender requirements that could bog you down.
• Some protections: Because they’re backed by Fannie and Freddie, conforming loans could come with certain protections in times of crisis, such as the foreclosure moratorium that the federal government enacted during the pandemic. Conforming loans are also barred from certain terms and practices that could be considered usurious, such as balloon payments. 

Cons

• Less accessible: Conforming loans can be difficult to obtain for borrowers with lower incomes and credit scores and higher DTI ratios.
• Not always sufficient: A conforming loan might not offer you enough funds if you’re looking to purchase a luxury home, or even a standard one in an expensive area, even with the higher loan limit in those places.

What is a nonconforming loan?

Mortgage loans that don’t meet the requirements for a conforming loan are considered to be nonconforming loans. Jumbo loans are nonconforming loans that exceed the maximum loan limit for an area — but loans can be nonconforming for other reasons beyond loan size. For example, many loans for commercial properties are nonconforming.

Compared to conforming loans, there is a much wider diversity of loan types and features among nonconforming loans. It’s important to remember that nonconforming mortgages often come with higher interest rates than conforming loans, although this is not always the case. The process of securing a nonconforming loan may also be quicker and require less documentation.

Nonconforming loan requirements

Lenders may demand that borrowers have higher credit scores, high cash reserves or assets and/or lower DTI ratios in order to justify the size or other conditions of a nonconforming loan, especially if it’s a jumbo loan. You can expect to put down a down payment of at least 10 to 20 percent if you’re planning on a jumbo, too.

Here are three common reasons borrowers don’t qualify for conforming loans:

• Loan size: If you’re borrowing more than $726,200 in much of the U.S., or more than $1,089,300 in high-cost areas such as Hawaii, you’ll need a nonconforming loan. Less than that and a conforming loan will do.
• Credit score: If you’ve experienced credit troubles and your FICO score is south of 620, you probably won’t qualify for a conforming loan. For borrowers with low credit scores, mortgages issued by the Federal Housing Administration (FHA) are a popular alternative. FHA loans allow for credit scores of 580 (or 500 with a higher down payment than the standard 3.5 percent.) One downside: Steep fees for mandatory mortgage insurance (MIP) can increase the costs of FHA loans. 
• A high DTI ratio: If your debts push you out of conforming-loan territory, you still might be able to get an FHA mortgage or a type of nonconforming loan known as a non-QM mortgage.

Pros and cons of nonconforming loans

Pros

• Expands your options: A nonconforming loan can widen your housing options by allowing you to buy in a more expensive area, or a type of home that isn’t eligible for a conforming loan.
• More accessible: Some mortgage lenders provide nonconforming loan solutions for borrowers with credit issues, including bankruptcy — making it a more accessible option (or indeed your only option). 
• Higher loan limits: You’re not limited on the amount you can borrow.

Cons

• Stiffer terms: Since nonconforming loans pose a greater risk, the lender will compensate with more stringent requirements, including higher down payment and liquidity/reserve requirements. 
• More expensive: Nonconforming loan interest rates tend to be higher than conforming loan rates. The lender may charge additional fees or higher closing costs, too.
• Higher risk: A lot of the criteria in conforming loans protects you from borrowing too much or getting delinquent. The absence of these makes it easier for you to fall behind or get into trouble on a nonconforming loan.

Conforming loan vs. nonconforming loan: Which is best for you?

If the price of your desired home is within conforming loan limits and your credit history meets eligibility requirements, you’re better off seeking a conforming loan, which generally has a lower rate and lower down payment requirement compared to a nonconforming loan.

A nonconforming loan is best reserved if you’re looking to buy a more expensive property and need a higher loan amount. It’s also a better choice if you have negative marks on your credit history or don’t meet the qualification criteria for a conforming loan. 

However, while nonconforming loans have more flexible requirements, they do have downsides as well, including potentially higher interest rates.

If you’ve decided that a nonconforming loan is the right choice for your situation, do your homework before selecting a mortgage  lender. Request loan estimates from several different lenders that offer nonconforming loans, then compare the interest rates and loan terms to ensure you find the best option. 

You can contact your bank and other lenders directly to ask them about the types of nonconforming loans they offer. Another avenue worth exploring: Find a mortgage broker who specializes in nonconforming loans. A good broker knows what’s available and can save you time and money.

Additional reporting by Taylor Freitas