Shopping for a mortgage? Now’s the time to familiarize yourself with one of the most popular types of home loans: 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 standard, and a good place to start when looking for financing.
What is a conforming loan?
Conforming loan definition
A conforming loan is a mortgage eligible to be purchased by Fannie Mae and Freddie Mac, the government-sponsored enterprises, or GSEs, because it meets — or conforms — to their standards, including limits on the amount that can be borrowed.
The 2022 conforming loan limit for a single-family home is $647,200 in most housing markets. In higher-cost areas, the limit is $970,800.
A common example of a conforming loan is a mortgage with a 20 percent down payment, a 15- or 30-year term, monthly principal and interest payments, no prepayment penalty, no balloon payment and no private mortgage insurance.
What are conforming loan standards?
Fannie Mae and Freddie Mac buy conforming loans from mortgage lenders and package them together to create mortgage-backed securities (MBS), which are then sold to investors. By selling conforming loans to Fannie Mae and Freddie Mac, lenders can obtain new capital to fund additional mortgages.
As such, a mortgage has to adhere to certain standards in order to be considered conforming and eligible to be purchased by the enterprises. Mortgages that conform to Fannie Mae and Freddie Mac requirements are easy for investors to buy and sell because they meet these standards, which include:
- Loan limit – $647,200 for a single-family home in most markets and $970,800 in higher-cost areas
- Credit score – At least 620
- 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/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
Can I still qualify with a lower down payment?
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.
What is the minimum credit score needed to qualify for a conforming mortgage?
Because a bigger down payment reduces their risk, lenders are willing to accept a borrower with a credit score as low as 620 for a conforming loan — but with two important caveats:
- Individual lenders can and do have their own, often higher credit standards, in addition to Fannie Mae and Freddie Mac requirements.
- A 620 credit score generally will not be enough to get the lowest interest rate. When offering the best rate possible, lenders look for borrowers with higher credit scores who represent less risk. If your credit score is 780 or higher, you’ll be much more likely to get the best available rate.
How will my debt ratios be evaluated?
To qualify for a conforming loan, lenders will also look to make sure you can afford your monthly mortgage payments by evaluating your debt ratios. There are two measures, sometimes expressed as 28/36:
- Front-end ratio: 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. For example, if your gross monthly income is $8,000, your allowable mortgage cost could be no more than $2,240 to be considered a conforming loan.
- Back-end ratio: 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 be considered a conforming loan, the maximum back-end ratio is 36 percent. So, if your gross monthly income is $8,000, your allowable debt payments could be no more than $2,880 to be considered a conforming loan.
It’s possible to get a conforming loan with higher debt ratios, but lower is generally the better case for both borrower and lender.
How flexible is the conforming loan limit?
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).
Keep in mind that requirements can vary in other ways, as well. For example, standards might be stricter for a cash-out refinance than for a rate-and-term refinance.
Pros and cons of conforming loans
- If you make at least a 20 percent down payment, that means there’s less money for you to borrow and also more home equity at the time you purchase your home. In turn, your monthly payments are lower compared to a loan with less money down.
- If you do put at least 20 percent down, you won’t need to pay for PMI, which represents significant monthly savings. Depending on your loan amount, PMI can cost a few hundred dollars per month.
- If you can put 20 percent down, and have good credit and strong financial reserves, you’re likely to qualify for the lender’s best rate and the lowest monthly payments overall.
- Your DTI ratio must meet conforming loan standards. The maximum DTI ratio is typically 36 percent, but that can stretch to 45 percent or even 50 percent if you have other “compensating factors,” such as a higher credit score.
- The home you want to buy could exceed conforming loan limits, especially if you’re in a higher-priced market.
Alternatives to conforming loans
Conforming vs. non-conforming loans
A conforming loan conforms to, or meets, Fannie Mae and Freddie Mac standards pertaining to the borrower’s credit, down payment and other factors like loan size. A non-conforming loan, on the other hand, does not conform to, or meet, these standards. For example, a jumbo loan is a non-conforming loan because the amount borrowed exceeds the Fannie Mae and Freddie Mac limit. 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 enterprises.
Conforming vs. conventional loans
A conforming loan must meet 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.
What are conforming loan rates?
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.
- Beware of rates that seem too low to be true given your financial position. Currently, the benchmark 30-year conforming conventional loan rate is 5.910%. If you do encounter a low rate, it could be that the value of the low rate will be offset by bigger upfront costs. Be sure to evaluate the complete cost of the loan carefully.
- Different lenders have different funding available and different costs. For this reason, it pays to shop around for the best rates and terms.
- 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.
How to get the best conforming loan for you
There are a number of steps you can take that can help you get the best conforming loan for your circumstances:
1. Check your credit report
As much in advance as possible, check your credit reports at AnnualCreditReport.com. Due to the pandemic, credit reports are now available at no charge on a weekly basis from Experian, Equifax and TransUnion through April 20, 2022. 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.
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 in process, 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.