Conforming loans: What they are and how they work

If you’re shopping for a mortgage, you may have heard the term “conforming loan” thrown around. But what does it mean, how does it work — and why should you consider getting one? Here’s everything you need to know about conforming loans and how they can benefit you.

What is a conforming loan?

A conforming loan refers to a type of conventional mortgage that aligns with the criteria set by the Federal Housing Finance Agency (FHFA). Meeting its standards makes these loans eligible to be purchased by Fannie Mae and Freddie Mac. By buying mortgages, Fannie and Freddie reduce risk for lenders. This practice also frees up more money for lenders to use to fund additional mortgages.

As a result, most mortgage lenders offer conforming loans, and conforming loans are mostly what they offer.

Within conforming loans, there’s the option for a fixed or an adjustable rate. Term lengths can also vary, with 15- and 30-year terms being the most popular.

Conforming loan limits and rules

A mortgage must abide by certain standards to be considered conforming and eligible for Fannie Mae and Freddie Mac to purchase. These requirements, which relate both to the borrower and the loan itself, include:

• Loan limit – 2024’s limits are $766,550 for a single-family home in most markets, but go up to $1,149,825 in higher-cost areas.
• Borrower credit score – At least 620
• Borrower debt ratios – Ideally, a debt-to-income (DTI) ratio of 36 percent or less, though it can go up to 50 percent with specific compensating factors
• Down payment/home equity – At least 3 percent down for a purchase or 5 percent equity for a refinance. However, if you put down less than 20 percent or have less than that in equity, you’ll need to pay private mortgage insurance (PMI) and will have a higher interest rate.
• Loan-to-value (LTV) ratio – As high as 97 percent, depending on the mortgage and the borrower

How the FHFA regulates conforming loans

The FHFA compares the increase or decrease in the average house price from October to October every year, as indicated by the Housing Price Index. It uses this percentage change as the basis to adjust loan limits. This method ensures that the loan limits reflect the realities of the current real estate market and allows buyers continued access to conforming mortgages.

Pros and cons of conforming loans

Conforming vs. non-conforming loans

A conforming loan conforms to the FHFA’s standards pertaining to the borrower’s credit, down payment and loan size. Fannie Mae and Freddie Mac will only purchase conforming conventional loans. A non-conforming loan doesn’t conform to these standards, 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 for purchase by the government-sponsored enterprises. For example, you may need a jumbo loan — one of the most common non-conforming types — to purchase a home that exceeds the conforming loan limit for that area.

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 to 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.

Different lenders have different financing products available. Also, 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 stays fixed for an introductory period, usually for 3 to 10 years, and is typically lower than fixed-rate loans. After that period, the rate will 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. Preapproval 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 will keep a close eye on your credit and spending 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 unneeded large purchases. This will help ensure the closing process goes smoothly and you receive the financing you’re expecting.

Conforming loans FAQ

• Why are conforming loan limits set each year?

  Conforming loan limits are set annually by the FHFA to account for housing market changes — rises or declines in the prices of homes. By adjusting their baseline loan limit, the FHFA allows average homebuyers to secure a conforming conventional mortgage despite increases in residential real estate costs.
  
  
  For 2024, the FHFA raised the baseline conforming loan limit to $766,550,200. In higher-cost regions, the limit is even higher — up to $1,149,825. This adjustment is part of the FHFA’s initiatives to support accessibility to mortgages for average buyers.

• 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. 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.

• Can I still qualify for a conforming loan with a lower down payment?

  A conforming loan can have a lower down payment as long as the borrower pays private mortgage insurance (PMI). By paying PMI, you can get a conforming loan with as little as 3 percent down if you have a Conventional 97, Fannie Mae HomeReady or a Freddie Mac HomeOne or Home Possible mortgage.

• How will my debt ratios be evaluated?

  To qualify you for a conforming loan, lenders evaluate how much monthly debt you’re carrying compared to how much money you make. There are two debt ratio measures, sometimes expressed as  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 obligations, such as an auto loan, student debt, personal loan and credit card payments. (To derive your DTI, use this handy calculator). For conforming loan consideration, the maximum back-end ratio is 36 percent. It’s possible to get a conforming loan with higher debt ratios, but lower is generally better for both borrower and lender.

Additional reporting by Maya Dollarhide