If you have ever applied for a mortgage, you may have heard lenders refer to loans as conforming or conventional without really giving it the time of day.
But if you are a mortgage lender, you are fully aware that referring to a loan as conforming and conventional doesn’t always mean the same thing.
A lot of confusion around conforming mortgages stems from the fact that only conventional loans can be conforming loans. However, not all conventional loans (as you will soon see) are conforming mortgages.
So, what makes a loan a conventional loan and what makes it a conforming loan? Can a conventional loan be conforming?
New Century Mortgage has finally decided to debunk the myths and misconceptions behind the conforming conventional mortgage loan debate.
What is a Conforming Loan?
Since the financial crisis of 2008, most consumers are familiar with the names Fannie Mae and Freddie Mac. These two quasi-government entities are mortgage aggregators that were placed into conservatorship under the oversight of the Federal Housing Finance Agency (FHFA)1.
Fannie Mae and Freddie Mac have deep roots within housing and financial markets and serve the purpose of purchasing mortgage loans, packaging them into mortgage-backed securities, and selling those loans to investors.
A conforming mortgage loan refers to a mortgage loan that meets Fannie Mae and/or Freddie Mac’s purchase requirements.
Most lenders sell most conforming mortgage loans to the secondary market. The sale usually happens a few months after the closing of the loan. Lenders may even take up to two months of escrows to cover this transition. Lenders choose to sell off these loans to increase liquidity, similar to that of a revolving line of credit.
However, just because a loan is sold doesn’t always mean the servicing of the loan necessarily changes. Lenders can receive income for administering and servicing the debt, often referred to as servicing rights.
An example of servicing responsibilities includes, but are not limited to, collecting monthly payments, maintaining escrows (where applicable), as well as providing information, notices, a copy of the note, and disclosures to the borrowers.
Types of Conforming Loans
Conforming loans are called conforming because they conform to Fannie Mae and Freddie Mac guidelines. Once a conventional loan has met this standard, then the conventional loan is now conforming. Not every conventional loan though is conforming, as these loans may not meet the Fannie Mae or Freddie Mac standard.
A conforming loan can be offered as either a fixed-rate or an adjustable-rate. Adjustable-rate mortgages are also referred to as variable-rate mortgages.
Fixed-rate mortgages inherently have an interest rate that is constant, meaning it doesn’t change over the life of the loan.
Adjustable-rate mortgages (ARMs) on the other hand may have an initial period where the rate is fixed, but after a certain point the repayment terms allow for the interest rate to adjust (either up or down, with certain periodic and lifetime caps) on a predetermined schedule. Please see your note for details, if applicable.
The increase or decrease is based on an index plus a set margin. Typical indices used are:
Fixed-rate mortgage loans are often advantageous for borrowers looking for a more stable or predictable monthly payment.
On the other hand, adjustable-rate mortgages can sometimes offer more favorable rates in the short term, benefiting those borrowers who are looking to pay off their mortgage within a specific time horizon.
Either option can be utilized for a purchase or refinance (both rate-term or cash out) transaction.
What is a Non-Conforming Loan?
While conventional mortgage loans can certainly be conforming loans, they do not always meet the conforming criteria outlined by Fannie Mae and Freddie Mac. Thus, conventional mortgage loans can also be non-conforming mortgage loans.
The two main reasons why a mortgage loan may be considered non-conforming is that it can either be purchased by another entity or the loan does not fall within the standard conforming loan limits2.
Types of Non-Conforming Loans
The two best examples of non-conforming mortgage loans are government-backed loans and jumbo mortgage loans.
As the name suggests, government-backed loans are loans that are insured by the federal government in some capacity.
In most cases, these loans are insured up to a certain threshold, protecting the lender in the event a borrower defaults on the debt. This lowers the risk of the lender who can then offer more favorable repayment terms to the borrower(s).
A few examples of government-backed mortgage loan programs are FHA, USDA, and VA loan programs. Many of these offer lower down payment requirements and more flexible underwriting criteria.
Jumbo mortgage loans are non-conforming mortgage loans that exceed the loan limit set by the FHFA, based on a variety of factors, that make them ineligible for purchase by Fannie Mae and Freddie Mac.
Since the jumbo mortgage loans usually carry higher loan amounts (as the name entails), they are often seen as carrying more risk compared to conforming counterparts. This usually means that certain lenders may require more rigorous credit standards and eligibility criteria.
Note that both government-backed and jumbo mortgage loans can both be offered as fixed-rate or adjustable-rate mortgages. However, because they do not meet the purchase criteria of either Fannie Mae or Freddie Mac, they wouldn’t be considered a conforming loan.
Comparing Conforming and Non-Conforming Options: Pros and Cons
If you are in the market for a new mortgage loan figuring out whether to go with a conforming or non-conforming option can be a bit tricky.
Thankfully, New Century Mortgage has been able to help borrowers just like you weigh the pros and cons of multiple mortgage financing options, outline key benefits that align with your particular end-goals.
Benefits of Conforming Loans
Conforming mortgage loans certainly have some benefits over their non-conforming counterparts.
For starters, conforming mortgage loans have fairly standard qualification requirements. While Fannie Mae and Freddie Mac are two separate entities, their underwriting criteria and eligibility requirements align very closely.
While individual lenders may have additional underwriting overlays, in general most conforming loans require similar criteria for approval. This also simplifies the comparison process if borrowers want to shop lenders to find the best rate and repayment terms.
Additionally, conforming conventional loans are probably the most widely offered solution that consumers can take advantage of. This is partially due to the fact that these loans carry less risk, as they are being sold off into the secondary market as opposed to remaining on the lender’s books.
Since there are a multitude of lenders that offer conforming conventional mortgage loans, consumers have more choices on who they want to do business with.
Lastly, while it is not always the case, in general conforming mortgages can often offer a lower interest rate compared to other non-conforming options.
Benefits of Non-Conforming Loans
Non-conforming mortgage loans can be ideal programs for clients, some may even offer lower rates than conforming. The only difference is the loan programs simply don’t meet the requirements to be a conforming mortgage loan, another words these loans do not ‘conform’ to the standards set out by Fannie and Freddie.
In fact, there are several benefits to going with a non-conforming mortgage solution. In some cases that might be your only option.
Generally, government-backed non-conforming loans can offer lower down payment requirements compared to conforming conventional loans2.
Some solutions may even waive a down payment altogether for borrowers who meet certain eligibility criteria. Most jumbo mortgage loan providers will still require a down payment.
However, jumbo mortgage loan options allow borrowers the flexibility of taking out a larger loan amount outside the conforming loan thresholds, assuming the applicant can carry the debt2. This can be beneficial for those transactions where the subject is a more expensive or unique piece of real estate.
Unlike conforming mortgage loans, non-conforming mortgage solutions are less restrictive with the types of real property being used as collateral. The same is true with respect to qualifying credit requirements, making non-conforming mortgage solutions much more individualized and flexible2.
1 HISTORY OF FANNIE MAE & FREDDIE MAC CONSERVATORSHIPS. (n.d.). Retrieved July 21, 2020, from https://www.fhfa.gov/Conservatorship/Pages/History-of-Fannie-Mae–Freddie-Conservatorships.aspx#:~:text=Long-term, continued operation in,Fannie Mae or Freddie Mac.&text=Until Congress determines the future,out its responsibilities as Conservator.
2 Is A Non-Conforming Loan Right For You? (n.d.). Retrieved July 21, 2020, from https://www.rocketmortgage.com/learn/non-conforming-loan