Differences Between Conforming Loans and Non-Conforming

Finding the Right Mortgage, Mortgages
Top Differences Between Conforming and Non-Conforming Loans Story

This will be a little peek into the inner workings of a home loan. It’s kind of like looking under the hood of a car. Lots of belts, hoses, metal and plastic — and who knows what all that’s about? But knowing a little something about the types of mortgages out there will help you get the best terms you can on the largest purchase of your life.

Conforming loans

The government-sponsored entities that drive the home loan market are known as Fannie Mae and Freddie Mac. These behind-the-scenes organizations provide a secondary market for mortgages — allowing lenders to package loans into investment bundles, sell them and lend again.

As part of their structure, they are legally bound to purchase various types of mortgage loans under a certain value, known as the “conforming loan limit.” The Federal Housing Finance Agency sets the national conforming loan limit, which is $424,100 in 2017 — but it can be more in some high-cost markets. For example, conforming loans can top out at $636,150 in Alaska, Washington, D.C., and metro areas in other high-demand housing markets. Limits are even higher in some cities in California and Hawaii.

So, to get a conforming loan — which is a good thing — you’ll want to buy a house that puts you under the conforming loan limit in your area.

» MORE: How much can you afford?

Jumbo home loans

This one is easy: Loans above the conforming limit are known as “jumbo” loans. The terms and conditions of these “non-conforming” mortgages can vary widely from lender to lender, but the mortgage rates for jumbo loans are typically higher because they carry greater risk to a lender.

The down payment for these types of loans are 20% or higher. Lenders typically have stricter qualifying criteria for jumbo loans, and you can expect more scrutiny of your credit profile and income.

» MORE: What you need to know about jumbo loans

Other non-conforming loans

Mortgage size is just one measure of non-conforming loans. Other factors can trigger the non-conforming loan label, and can include:

  • Credit history issues or a low credit score.
  • Too much debt in relation to how much you earn (your debt-to-income ratio).
  • A down payment less than 20% of the home’s value (which affects your loan-to-value ratio).

One important note: A lower down payment doesn’t always trigger a non-conforming loan. In fact, Fannie Mae has a 97% loan-to-value program for first-time homebuyers. As long as that program is in effect, you can make a 3% down payment and still have your loan classified as conforming. Fannie Mae also offers a 5% down program for non first-timers.

» MORE: Loan-to-value calculator

What it means to you

A conforming loan usually offers a lower interest rate and lower fees. Lenders like them because they can sell the loan, which frees up capital and lets them make more loans.

If you can’t qualify for a conforming mortgage, you might want to apply for an FHA loan. The Federal Housing Administration helps potential homeowners qualify for a mortgage by guaranteeing a portion of the loan. Unfortunately, that support will cost you additional fees.

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Hal Bundrick is a staff writer at NerdWallet, a personal finance website. Email: hal@nerdwallet.com. Twitter: @halmbundrick.

This post was updated Dec. 21, 2016. It originally published May 26, 2015.

Image via iStock.