Shopping for a mortgage? Now’s the time to familiarize yourself with one of the most popular types of financing tools: a conforming loan. It’s the go-to mortgage for borrowers with solid credit and enough cash or home equity for a sizable down payment.

In a marketplace with lots of mortgage options, a conforming loan is the gold standard and a good place to start when looking for financing. Here’s how these mortgages work, their pros and cons, and how to get the best conforming loan for your needs.

What is a conforming loan?

A conforming loan refers to a type of mortgage that aligns with the criteria set by the Federal Housing Finance Agency (FHFA). Conforming to, or meeting, these established standards makes these loans eligible to be purchased by government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. Since Fannie and Freddie buy most of the mortgages in the U.S., this is a big deal for lenders, going a long way towards alleviating their risk when they extend financing to you. In fact, some financial institutions will only deal in conforming loans.

A typical conforming loan/mortgage involving a 20 percent down payment, with a choice between a 15- or 30-year term. Monthly payments cover both principal and interest. It does not come with prepayment penalties, balloon payments, or mandatory private mortgage insurance.

How do conforming loans work?

After you take out a conforming loan from a lender, here’s what happens next:

  1. After your loan closes, your lender submits your loan to either Freddie Mac or Fannie Mae for purchase. They thoroughly examine your loan paperwork, request clarification on any necessary details and eventually add the loan to their portfolio (buy it, that is) while compensating your lender. By selling conforming loans to Fannie Mae and Freddie Mac, lenders can obtain new capital to fund additional mortgages.
  2. Freddie Mac and Fannie Mae package these loans together to create mortgage-backed securities (MBS), which are then sold to investors. Investors rely on MBSs as a consistent source of income (provided by the mortgage holders’ monthly payments). MBS are somewhat like mutual or exchange-traded funds: Each may contain a large number of loans, sometimes as many as 1,000.
  3. This consistent stream of MBS results in the establishment of a secondary mortgage market, fostering a continuous demand for fresh mortgages.

Conforming loan limits and rules

A mortgage must abide by certain standards to be considered conforming and eligible to be purchased by Fannie Mae and Freddie Mac. These requirements include:

  • Loan limit – $726,200 for a single-family home in most markets and $1,089,300 in higher-cost areas
  • Borrower credit score – At least 620
  • Borrower debt ratios – Ideally, a front-end ratio of 28 percent or less and a back-end ratio, also known as the debt-to-income (DTI) ratio, of 36 percent or less
  • Down payment/home equity – Ideally, at least 20 percent down for a purchase or 20 percent equity for a refinance; however, Fannie and Freddie also back conventional loans with as little as 3 percent down
  • Loan-to-value (LTV) ratio – Ideally, 80 percent or lower; again, Fannie and Freddie also back conventional loans with an LTV max of 95 percent to 97 percent, depending on whether it’s an adjustable- or fixed-rate mortgage, or if you’re a first-time homebuyer

Pros and cons of conforming loans

Pros

Pay less each month: If you make at least a 20 percent down payment, that means your debt load is smaller, and you also immediately own a larger amount of the home outright when you close. In turn, your monthly payments are lower compared to a loan with less money down.

No PMI: If you do put at least 20 percent down, you won’t need to pay for private mortgage insurance (PMI), which represents significant monthly savings. Depending on your loan amount, PMI can cost a few hundred dollars per month, and you can’t get rid of it until you’ve  build up enough equity and/or reach a certain LTV ratio.

Better rates and terms: If you can put 20 percent down, and have good credit and strong financial reserves, you appear as a more creditworthy borrower candidate to the lender. Consequently, you’re likely to qualify for the lender’s best interest rate and the lowest monthly payments overall.

Easier to get: Conforming loans are among the most common type of mortgages, and it’s usually easier to qualify for a conforming mortgage loan than a non-conforming mortgage loan. That’s because lenders can set stricter eligibility requirements, including a higher minimum credit score, for a non-conforming loan — and often do, to offset the greater risk.

Cons

Limits on debts: Your DTI ratio must meet conforming loan standards set by the FHFA. The maximum DTI ratio is typically 36 percent. Sometimes, that can stretch to 43 percent or even 50 percent if you have other “compensating factors,” such as a higher credit score. But overall, your lender might be more limited in what it can do for you.

Borrowing limits: The home you want to buy could exceed conforming loan limits, especially if you’re in a higher-priced market.

More upfront money needed: You will often need to put down 20 percent for a conforming loan, especially if you want to avoid PMI. A government loan, on the other hand, can be had for 0 to 3.5 percent down if you qualify.

Higher credit score needed: You typically need a credit score of 620 or higher for a conforming loan, whereas some government loans can be had for a score as low as 500.

Conforming vs non-conforming loans

A conforming loan conforms to or meets the FHFA’s standards pertaining to the borrower’s credit, down payment and other factors like loan size, allowing Fannie Mae and Freddie Mac to purchase it. A non-conforming loan — you guessed it — does not conform to, or meet, some or all of these standards. And so Fannie and Freddie won’t buy it from the lender.

The fact that a loan is non-conforming doesn’t mean it’s bad, however; it simply means that it doesn’t meet the criteria to be purchased by the government-sponsored enterprises. You may need a non-conforming (jumbo) loan, for example, if you seek to purchase a more expensive home that exceeds the conforming loan limit for that area.

Opting for a non-conforming loan opens up a range of housing possibilities, enabling you to purchase a property in a higher-priced area or acquire a type of home that wouldn’t qualify for a conforming loan. Additionally, some mortgage lenders offer nonconforming loan options tailored to borrowers with credit challenges or sketchy histories — like a bankruptcy in their recent past. The lender has more leeway in approving applicants, since it doesn’t have to meet the federal standards.

Of course, it has more leeway in setting fees, terms and other conditions too. Nonconforming loans often charge higher interest rates than conforming loans, or impose more fees.

Conforming vs conventional loans

Both conforming loans and conventional loans refer to private (non-government) and commercial mortgage loans. And their meanings overlap.

But “conventional loan” is a broader category. A conforming loan is one that meets specific criteria set by the FHFA, including conforming loan limits. A conventional loan is any loan that isn’t guaranteed or insured by the government (FHA, VA and USDA loans). Conventional loans can be either conforming or non-conforming.

In short: All conforming loans are conventional loans, but not all conventional loans are conforming loans.

How to get the best conforming loan for you

There are several steps you can take that can help you get the best conforming loan for your circumstances:

1. Check your credit report

As far in advance as possible, check your credit report and history at AnnualCreditReport.com. Check your reports carefully for out-of-date items and factual errors. Dispute any errors you spot, because even minor issues can result in a lower credit score.

2. Get your documents in order

Get your paperwork together so you’re prepared for the mortgage application process. Lenders can now get a lot of information directly from banks and the IRS, but it’s still a good idea to have documents like payroll stubs, bank statements, retirement accounts, W-2 forms and tax returns handy.

3. Compare loan rates

Take the time to compare mortgage offers from at least three different lenders. Consider your needs and preferences when creating a short list of lenders to work with — you might want to start with your bank (if it offers mortgages), or consider a credit union or online lender, for example. Beyond the general terms of the loan, look closely at each lender’s fees and points, if available.

Different lenders have different financing products available, and what’s more, the same sort of loan’s terms may vary, depending on your creditworthiness.

You can find conforming loan rates through Bankrate, which provides mortgage rates for both 30-year and 15-year loans daily. When comparing mortgage rates, consider the following:

  • If you think interest rates will rise in the coming month or so, you might choose to lock your rate to ensure the lowest rate possible.
  • Interest rates may differ depending on your credentials as a borrower. Beware of rates that seem too low to be true given your financial position. If you do encounter a low rate, it could be that its percentage will be offset by bigger upfront costs. Be sure to evaluate the complete cost of the loan (interest rate and fees) carefully, as indicated by its annual percentage rate (APR).
  • Remember that you can get either a fixed- or adjustable-rate mortgage. A fixed-rate mortgage generally ranges from 10 to 30 years, and the interest rate remains the same for the life of the loan. With an adjustable-rate mortgage, your interest rate can fluctuate based on market factors.

4. Get preapproved

Once you find a lender you’re interested in working with, you can get preapproved for a loan, which can help expedite the financing process and uncover any issues related to your credit before they show up when you formally apply for a mortgage. Getting preapproved also helps demonstrate to a home seller that you’re a serious buyer.

5. Avoid excessive spending

Lenders can check and re-check your credit report and score and various financial accounts right up until your mortgage closing date. Think of the time between when you apply for a loan and when you close as a “quiet” period, when you spend as little as possible. While your mortgage application is processing, don’t apply for any new credit, such as a credit card or personal loan, and avoid spending on things you don’t really need. This will help ensure the closing process goes smoothly and you receive the financing you’re expecting.

Conforming loans FAQ

  • Unfortunately, one of the immovable standards for conforming loans is the loan limit — you can only borrow so much and no more. Loan limits are set by the Federal Housing Finance Agency (FHFA) and are generally adjusted each year, with higher limits for properties with two, three and four units (as long as you live in one of the units). One workaround is a piggyback loan, in which you get a smaller mortgage atop a larger one: Together they add up to enough to finance the home.
  • A conforming loan can have a lower down payment as long as the borrower pays private mortgage insurance, or PMI. (In effect, you swap a big down payment for backing by a strong third party.) By paying for PMI, you can get a conforming loan with just 5 percent down in many cases, or as little as 3 percent down if you have a Conventional 97, Fannie Mae HomeReady or a Freddie Mac HomeOne or Home Possible mortgage.
  • To qualify you for a conforming loan, lenders evaluate your debt ratios. There are two debt ratio measures, sometimes expressed as 28/36: the front-end and back-end.

    The front-end ratio measures how much of your gross monthly income is allocated to your mortgage, including the monthly payment (principal and interest), property taxes, insurance and HOA fees (if applicable). Typically, lenders look for a front-end ratio of 28 percent or less. The back-end ratio, also called the debt-to-income (DTI) ratio, includes the front-end ratio plus other monthly debt obligations, such as auto loan, student debt, personal loan and credit card payments. (To derive your DTI, use this handy calculator). To be considered a conforming loan, the maximum back-end ratio is 36 percent. It’s possible to get a conforming loan with higher debt ratios, but lower is generally the better case for both borrower and lender.