Conforming and Non-Conforming Mortgages

Understanding These Mortgage Types

Conforming and Non-Conforming Mortgages
May 21, 2014

Mortgage loan classifications can be confusing. For example, how can a non-conforming loan be a conventional loan? Conforming, non-conforming, conventional, jumbo... what do they all mean and what is the difference? Perhaps we can help. Let’s start with some definitions:

  • Conforming – Conforming loans are at or below the dollar amount that Fannie Mae or Freddie Mac can purchase. These limits are set by the Federal Housing Finance Agency (FHFA) and may be found at the FHFA website on the Conforming Loan Limit link, along with past limits.

    The 2008 Housing and Recovery Act established a permanent formula for calculating conforming loan limits. The formula applies to any loan that Fannie Mae and Freddie Mac purchased in a given year that originated before July 1, 2007 or after September 30, 2011.

    For most areas, the limit is $417,000 for single unit properties, with scaled higher limits for up to four-unit properties. There are designated "high-cost" areas where this limit has been raised – up to $625,500 in some areas. Alaska and Hawaii have a higher overall limit of $625,000 and high cost designations that are further beyond this limit.

    Just because a loan is conforming does not necessarily mean that Fannie Mae or Freddie Mac owns it. They just set the definition by dollar amount and location.

  • Non-Conforming/Jumbo – A loan amount larger than the conforming loan limit is considered non-conforming, and is also known as a jumbo loan.

    Because of increased risk to the lender, jumbo loans usually carry higher interest rates (often 0.25-0.50% higher than a corresponding 30-year fixed loan, but as of April 2014, they are virtually identical).

    For jumbo loans, lenders may require higher credit scores, more down payment money, lower LTV (Loan-to-Value) ratios, a lower DTI (Debt-to-Income) ratio, and payment verification of six to twelve months of verified cash reserves.

  • Conforming High Balance – Sometimes called by the oxymoronic name "Conforming Jumbo Loans", these refer to the high cost areas listed above. They are between conforming and non-conforming – above the limit of $417,000 and yet considered conforming by FHFA standards. With higher risks, they often carry slightly higher rates and stricter qualifications, but not so much as a non-conforming loan.

    During the housing crisis, various temporary limits for these loans were passed via legislation. For example, FHA jumbo limits were temporarily raised to $729,750, but this limit expired at the beginning of 2014.

  • Conventional – A loan that is not insured by, or made by, the government. That's all it means. Conventional loans may or may not be conforming, and conforming loans may or may not be conventional.

Conforming, non-conforming, and jumbo all refer to the loan amount. Conventional refers to the loan backing.

To understand the risk differences, consider that banks often sell mortgages to free up cash for new loans. Conforming loans are easier to sell to Fannie Mae/Freddie Mac, or to package into mortgage-backed securities for investors, because of their better repayment record.

As non-conforming loans cannot be sold to Fannie or Freddie, banks must package them as jumbo mortgage-backed securities which are then sold to investors, or hold the loans themselves. The housing crisis effectively wiped out jumbo securities; they are just now recovering and banks are a bit apprehensive.

So what does this mean in practical terms? You can acquire a jumbo loan, but expect greater scrutiny and stricter requirements. If you can afford enough down payment money to stay under the conforming limit, it will generally be to your advantage (although today's interest rates are an anomaly).

Whether you go conforming or non-conforming, make sure your lender can explain the differences, details and features of their loan offer to your satisfaction. Otherwise, before deciding on a loan, you may need a new lender!

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