Buying your first home, and not sure what all the lender lingo means?
Keep a glossary handy when you shop for a mortgage because the terminology gets confusing quickly. And that starts with a basic distinction: whether you want a conforming mortgage or a nonconforming loan.
When you sit down with your loan officer to talk through your mortgage options, you need to know the difference between the two.
Conforming vs. Nonconforming Mortgage Loans
While there are many types of mortgage loans, all fall into two broad categories: conforming or not conforming.
The former “conform” to a loan program set out by either Fannie Mae (the Federal National Mortgage Association or FNMA) or Freddie Mac (the Federal Home Loan Mortgage Corporation or FHLMC). That matters because your lender can then turn around and sell your loan to Fannie Mae or Freddie Mac.
Banks and mortgage lenders like this model because they don’t have to hold onto loans and service them. They can turn around and lend their limited capital to someone else. They make their money on fees and closing costs, not long-term interest.
To standardize the loans they buy, Fannie Mae and Freddie Mac provide lenders with a list of acceptable loan policies. These different loan programs serve different types of borrowers. For example, borrowers with excellent credit may qualify for low-interest loans with low down payments. Borrowers with weaker credit qualify only for higher-interest loans with higher down payment requirements.
- Sellable on Secondary Market. Loans conform to Fannie Mae or Freddie Mac guidelines, so lenders can immediately sell them after closing.
- Stricter Requirements: Designed to be bought and sold by private companies, these loans typically serve borrowers with at least fair credit scores, who can document their income.
- Usually Cheaper: As a general rule, conforming loans that fit neatly into these loan programs have lower interest rates and cost less for the borrower than nonconforming loans.
- Common: Conforming loans are the most commonly issued mortgage loans in the U.S.
- Loan Amounts Limited: In 2022, most conforming loans max out at $647,200, although in some areas with a high cost of living they can go as high as $970,800.
- Sold or Held: Depending on the type of loan, lenders may sell nonconforming loans on the secondary market, or they may keep them on their own books.
- Niche: Different types of nonconforming loans tend to serve different types of niche borrowers, such as first-time homebuyers with weak credit, or military servicemembers.
- More Expensive: Often nonconforming loans have higher interest rates and fees.
- No Inherent Loan Limits: In the absence of strict loan program rules from Fannie Mae or Freddie Mac, lenders can issue larger loans.
Which loan type fits you best depends both on you and on your needs.
Generally speaking, average middle-income borrowers with good credit should stick with conforming loans.
Designed for stronger borrowers, these loans are priced by market forces. They’re not subsidized by the federal government. Lenders issue these loans fully expecting to be paid back in full, so they don’t have to price in the uncertainty associated with higher-risk products like FHA loans.
But that also means not everyone qualifies for conforming loans.
Eligibility Requirements for Conforming Mortgages
To qualify for a conforming mortgage loan, borrowers must meet the following basic criteria:
- Minimum Credit Score: Most conforming loan programs require a minimum FICO score in the 620-650 range. To get the best rates and lowest down payment, you usually need a credit score over 740.
- Maximum Debt-to-Income (DTI) Ratio: Conforming loans allow a maximum “front-end ratio” of 28%. This means the mortgage payment — including principal, interest, property taxes, homeowners insurance, and any homeowners association fees — cannot exceed 28% of your gross monthly income. They also cap the “back-end ratio,” limiting your total monthly debt commitments to 36% of monthly income. These debt commitments include car payments, student loans, and credit card minimums.
- Maximum Loan Size: Conforming loans cap the total loan amount at $647,200 in most of the US. In areas with a high cost of living, conforming loans go as high as $970,800. Check the Federal Housing Finance Agency’s website for the conforming loan limit in your area.
- Minimum Down Payment: Some conforming loan programs, such as Fannie Mae’s HomeReady program, allow a down payment as low as 3%. But most conforming loans require a down payment between 5-20%, or higher for weaker borrowers.
- Property Type: You can only take out a conforming loan for residential properties with up to four units. That includes primary residences, second homes, and investment properties.
Conforming vs. Conventional Loans
Borrowers often confuse the term “conforming loan” with “conventional loan.” While related, they aren’t the same.
Conventional loans refer to any privately-issued mortgage loan. They include conforming loans backed by Fannie Mae or Freddie Mac as well as loans held by lenders on their own portfolios. Conventional loans do not include loans issued directly by the government, such as FHA, VA, or USDA loans.
Advantages of Conforming Mortgages
Conforming mortgages come with plenty of benefits, especially for strong borrowers.
- Competitive Pricing. Lenders want your business. As long as you qualify for a conforming loan program, they have broad flexibility to negotiate interest rates and fees with you. This makes it easier to comparison-shop and push for lower rates and fees.
- Removable PMI. If you take out a mortgage for more than 80% of the property’s value, you have to pay extra each month for private mortgage insurance (PMI). But once you pay down your balance below an 80% loan-to-value ratio, you can apply to remove it from your monthly payment.
- Potential for Low Down Payment. If you have excellent credit and can clearly document your income, you could qualify for a down payment as low as 3%, without paying high interest or fees.
- Standardization and Availability. You can call up any conventional mortgage lender in the country and expect them to work with the same conforming loan programs dictated by Fannie Mae and Freddie Mac. That makes it easy to shop around for the best rate and terms.
Disadvantages of Conforming Mortgages
If conforming loans were for everyone, we wouldn’t need to distinguish between conforming and nonconforming loans.
Depending on your qualifications and needs, you may not make a good fit for conforming loans.
- Rigidity. By their very definition, conforming loans must fit neatly within a specific loan program dictated by Fannie or Freddie. You have to qualify for one of these precise loan programs.
- Loan Limits. Otherwise perfect borrowers, with outstanding credit and high income, still run afoul of conforming loans if they want to borrow more than the allowed limit.
- Credit Requirements. Prospective homebuyers with bad credit need not apply for conforming loans.
- Limits for Investors. Most conforming loan programs only allow a handful of mortgages to appear on the borrower’s credit report, for the borrower to qualify. Usually, the limit is four. That caps the number of conforming loans you can use as a real estate investor, before you have to switch to private lenders who keep their loans within their own portfolios.
Every mortgage loan that doesn’t fit within one of Fannie Mae’s or Freddie Mac’s loan programs falls under the category of “nonconforming.”
That umbrella includes a wide range of loan types designed for very different borrowers.
Types of Nonconforming Mortgages
While there technically endless types of nonconforming loans, most fall into a few distinct groups.
- Jumbo Loans. Lenders refer to large loans that exceed the size limits set for conforming loans as “jumbo loans.” Jumbo loans are for high-income borrowers looking to buy or refinance expensive homes. Even if you have excellent credit, you’ll likely pay more for a jumbo loan than a comparable conforming loan.
- FHA Loans.Another common nonconforming mortgage is the Federal Housing Administration (FHA) loan. FHA loans are designed for first-time homebuyers with lower income and weaker credit but come with some additional caveats and costs.
- VA Loans. For military servicemembers, veterans, and their spouses, the Department of Veterans’ Affairs offers subsidized VA loans. They come with a famous 0% down payment option.
- USDA Loans. The final common nonconforming loan program is USDA loans, designed for rural properties. They too allow a 0% down payment.
Eligibility Requirements for Nonconforming Mortgages
The eligibility requirements vary for nonconforming mortgages, depending on the loan type.
- Minimum Credit Score: Jumbo mortgages require a credit score of at least 680, and more often in the 700s. FHA loans allow scores as low as 500, but for the juicy 3.5% down payment, you need a score of at least 580. VA loans have no minimum credit score. USDA loans typically require a score of 640 or better.
- Minimum Debt-to-Income Ratio: Jumbo loans sometimes allow higher DTI ratios than conforming loans, such as Rocket Mortgage’s 45% back-end ratio limit. The FHA caps front-end DTIs at 31%, and back-end DTIs at 43%. Lenders only consider the back-end ratio for VA loans, allowing up to 41%. For USDA loans, you can borrow up to 29% based on your front-end ratio, and 41% for your back-end ratio.
- Maximum Loan Size: Jumbo loans, VA loans, and USDA don’t come with upper limits. For FHA loans, loan limits vary by local housing market, with the lowest limit set at $420,680 and the highest limit set at $970,800 for 2022. You can see your local FHA loan limit on HUD’s website.
- Minimum Down Payment: Borrowers with jumbo loans can typically expect to put down at least 10%, often 20% or even higher. FHA loans allow a down payment as low as 3.5% for borrowers with credit scores over 580, and a 10% down payment for those with credit scores between 500-579. The VA and USDA loan programs allow no down payment at all, for qualified borrowers.
- Property Type: Like conforming loans, nonconforming loans allow up to four units. However you must only use FHA, VA, and USDA loans to buy primary residences.
Advantages of Nonconforming Mortgages
Within their respective niches, nonconforming loans are often not just the better option, but the only option for buying a home.
1. Larger Loans. Higher-income borrowers looking to buy a pricey home exceeding the conforming loan limits have no choice but to take out a jumbo loan.
2. Credit Flexibility. Nonconforming loans make it possible for even borrowers with bad credit to buy a home.
3. DTI Flexibility. Borrowers with good credit but high DTI ratios that exceed conforming loan limits must look to nonconforming loans.
4. Potential for Lower Down Payment. The FHA down payment of 3.5% for even borrowers with weak credit puts homeownership in reach for millions of Americans. And the 0% down payment option among VA and USDA loans doesn’t exist anywhere else.
Disadvantages of Nonconforming Mortgages
These loans come with their fair share of drawbacks, depending on the specific program.
1. Life-of-Loan Mortgage Insurance for FHA Loans. Among the greatest downsides of FHA loans, borrowers must continue paying the mortgage insurance premium (MIP) for the entire life of their loan. So even after you pay the balance below 80% of your home’s value, you keep paying it, adding to the total cost of homeownership.
2. Higher Costs. Jumbo loans and FHA loans tend to cost more than their conforming counterparts, as they come with higher risk for the lender. They may have higher mortgage rates and more fees.
3. Strict Eligibility for the Best Loans. If VA loans and USDA loans seem to offer terms too good to be true, that’s because they’re subsidized by taxpayers to benefit specific segments of the population. Which is great if you’re a veteran or rural dweller, but no one else qualifies for them.
4. Less Standardization and Availability. Fewer mortgage lenders offer nonconforming loans, although you should still find plenty of options.
5. More Red Tape and Hassle. Government-issued loans such as FHA, VA, and USDA loans come with all the extra paperwork, delays, and other headaches you’d expect from the federal government. The rigid underwriting adds to the risk of the loan falling through as well. That not only makes them inconvenient for you as a borrower, but it also makes sellers less likely to accept offers financed by government-issued loans.
The Verdict: Should You Choose a Conforming or Nonconforming Mortgage?
There is usually a best loan option for any given borrower and situation. But that best option varies based on you and your needs.
You Should Choose a Conforming Mortgage If…
As a general rule, you should take out a conforming loan if you qualify for one and can afford the down payment.
A conforming mortgage is a better fit if:
- You Have Good Credit. Borrowers with strong credit can usually avoid the higher costs and stricter rules of an FHA loan.
- Your Loan Doesn’t Exceed the Local Limit. If you can keep your loan amount under the local conforming loan limit, you can qualify for a lower rate, fees, and down payment.
- Your DTI Ratio Doesn’t Exceed the Limit. If you don’t need a high loan amount relative to your income, stick with a conforming mortgage.
- You Can Afford a Substantial Down Payment. Most conforming loans require more than FHA’s 3.5% down payment. A 5% down payment is the bare minimum; 20% is ideal.
- You Don’t Qualify for a VA or USDA Loan. These two subsidized loan programs are usually too good to pass up — if you qualify for them.
You Should Choose a Nonconforming Mortgage If…
These vary depending on which nonconforming loan program you’re considering.
A nonconforming mortgage is a better fit if:
- You Qualify for a VA or USDA Loan. With their 0% down payment and other perks, look at these first if you qualify.
- You Have Weak Credit. If your credit score needs improvement, and you don’t like or don’t qualify for a conforming loan, consider an FHA loan.
- You Need a Jumbo Loan. It doesn’t matter how high your credit score or income are if you need to borrow more than conforming loans allow.
- You Need a Higher DTI Ratio. Nonconforming loans typically allow higher debt-to-income ratios on both the front and back end.
- You Have Little Cash for a Down Payment. For cash-strapped homebuyers, the 3.5% down payment with FHA loans makes a tempting option.
Understanding the difference between conforming and nonconforming loans makes your first conversation with loan officers much easier.
Talk through the different loan options with them, and make sure you ask the name of specific loan programs when they quote you. For example, borrowers with excellent credit can shop around for pricing on Fannie Mae’s HomeReady loan program or Freddie Mac’s Home Possible program, both of which allow a 3% down payment. That makes it easier to collect price quotes from different lenders for the same loan program.
Most of all, don’t let the process intimidate you. Take your time, learn the terminology, and find the right loan program for you and your needs.