If you’re entering the homebuying market for the first time, you might be overwhelmed by the number of loan options available. With so many options available and interest rates still high, it can be hard to tell which mortgage is right for you.
A conforming loan is a type of conventional mortgage that allows homebuyers to make a low down payment. Conforming loans are great for a first-time homebuyer on a budget, or someone looking to refinance their home. However, there are some caveats.
Here’s everything you need to know about conforming loans, including their pros, their cons and alternatives.
What Is a Conforming Loan?
A conforming loan is a type of mortgage that meets the standards set by government-supported mortgage entities Fannie Mae and Freddie Mac and their regulating agency, the Federal Housing Finance Agency. This is one of the most common types of mortgages and offers several advantages for most homebuyers, but it comes with limits.
To understand how conforming loans work, we must break down Fannie Mae and Freddie Mac’s role in the mortgage market. Both Fannie Mae and Freddie Mac are government-sponsored entities that are regulated by the FHFA. They provide loan guarantees to reduce the risk to borrowers, helping to make home loans more accessible. To be eligible for a Fannie Mae or Freddie Mac guarantee, a loan must meet — or conform to — certain standards set by the FHFA, including a value limit.
Confused? Here’s the simple definition: A conforming loan is a home loan under a certain amount that meets FHFA standards.
How It Works
Conforming loans aren’t provided by Fannie Mae or Freddie Mac. Rather, they’re funded by a typical lender, like a bank or credit union, and backed by the GSEs. This creates a guarantee for the lender, allowing it to offer more affordable loans.
To get a conforming loan, you’ll apply with your lender just like you would for any conventional home loan.
2024 Conforming Loan Limits
The baseline conforming loan 2024 limit is $766,550 for a one-unit property. In high-cost areas, including San Francisco, New York and Hawaii, the maximum loan limit is $1,149,825.
Conforming loan limits change every year as housing prices fluctuate. Ask your lender about your area’s loan limit before applying.
Other Requirements
In addition to the value limit, a borrower must meet these conventional loan requirements:
- A minimum credit score of 620
- A maximum debt-to-income ratio of 49%, depending on other compensating factors
- A minimum down payment of 3%
Pros and Cons of Conforming Loans
A conforming loan can be great for a homebuyer purchasing a standard family home on a set income. However, this type of loan also comes with some drawbacks.
Here are a few pros and cons to consider.
Pros
- Widely available: Most lenders offer conforming loans, so you can easily compare lenders and find the best loan for your purchase.
- Low down payment: Conforming loans allow down payments as low as 3%.
- Fast process: Conforming loans are highly standardized, making the loan process fast and transparent in most cases.
- Minimal requirements: The credit score and debt ratio requirements for conforming loans are less stringent than with some other mortgage options.
Cons
- Value limit: Conforming loans are limited to $766,550 in most counties.
- Mortgage insurance required for low down payments: Your lender will most likely require mortgage insurance if you provide a down payment lower than 20%.
- Only for one-unit properties: Conforming loans are typically reserved for one-unit properties, also known as single-family homes. This might not be the best loan type for a multi-unit property investment.
- Standardized requirements: Although the requirements for a conforming loan aren’t as strict as for many mortgage options, they are stricter than some types of government loans. They’re also relatively inflexible — you won’t be able to negotiate around a lower credit score.
Conforming vs. Nonconforming Loans
If a mortgage doesn’t meet the FHFA standards for a Fannie Mae or Freddie Mac guarantee, it’s known as a nonconforming loan.
Nonconforming home loans are also conventional mortgages, and they’re considered reliable options for borrowers who don’t meet the conforming loan requirements. Some common types of nonconforming conventional loans include jumbo loans, which are used to fund high-value investments, and government-backed loans, which are offered to borrowers with poor credit.
Conforming Loan Alternatives
Although conforming loans are common, they aren’t your only option. Homebuyers who have a low credit score, exceed the value limit in their area or want to explore other mortgage types should look into these alternatives.
FHA Loans
An FHA loan is a type of nonconforming conventional loan offered by the Federal Housing Administration. These loans are available to homebuyers with a credit score of 580, or 500 with at least a 10% down payment. You might want to consider an FHA loan if you have low credit, have a steady income and want a more affordable mortgage option.
Other government-backed mortgage options include Department of Veterans Affairs loans and Department of Agriculture loans. These options also have minimal credit requirements but are available only to select homebuyers.
Owner Financing
With owner financing, also known as a holding mortgage or owner-carry loan, the seller acts as the lender. The buyer pays the seller directly instead of taking out a mortgage with a third party. This type of loan offers a lot of flexibility; however, it can be risky, as there’s no government backing and the terms established by the seller may not be guaranteed.
Balloon Mortgage
A balloon mortgage is a short-term home loan that allows the buyer to make small monthly payments for a limited period. Once that period is over, the remaining balance is due all at once. Some balloon mortgages even allow no payments for five to seven years.
Balloon mortgages are risky, but they can be a good choice for someone who expects to sell the home within a few years or is waiting on a large windfall payment, like an inheritance.
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