What Is a Conforming Home Loan?
A conforming home loan complies with the requirements of conventional lending as established by the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac). The financial institution that issues you a mortgage can turn around and sell it to one of those agencies if the loan conforms to their standards. Generally, this enables you to get a lower interest rate as you are considered a good bet to pay your loan back.
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What is it?
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Broadly speaking, mortgages are either backed through the government or through the private sector. Loans can be insured by the Federal Housing Administration (FHA) or guaranteed by the Veterans Administration (VA). In the private sector, a conforming loan is eligible for purchase by Freddie Mac or Fannie Mae. By selling mortgages, financial institutions replenish their coffers so they can issue new loans to home buyers.
Conforming Lending Types
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Conforming loans are offered in a variety of programs, such as fixed-rate mortgages with 15- or 30-year terms and adjustable rate mortgages (ARMs) in which the interest rate changes at specified intervals. The interest rate on ARMs is keyed to a price index, such as Treasury bill rates. As of the start of 2009, the maximum conforming loan was $417,000 ($625,000 in areas deemed high cost). Fannie Mae and Freddie Mac will also buy bigger mortgages, known as jumbo loans, but the borrower will pay a slightly higher interest rate.
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Benefits of Conforming Loans
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Conforming loans offer borrowers a wider variety of mortgage programs and the opportunity to obtain larger amounts than with FHA-insured mortgage programs. Renters benefit indirectly if landlords pass along savings from obtaining cheaper mortgages on multi-unit housing. Lenders benefit from conforming loans because they have a ready secondary market to buy their mortgages.
History
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In the wake of the Great Depression, many homeowners faced foreclosure. With little money to lend, banks required down payments as high as 50 percent. In 1934, President Franklin Roosevelt created the Federal Housing Administration (FHA) to insure mortgage loans in the case of default. In 1938, Fannie Mae was created to pump more money in the banking system by buying up mortgages, provided they conformed to specified standards. In 1970, Congress chartered Freddie Mac to provide additional mortgage money.
Nonconforming or Subprime Loans
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During the first decade of 2000, a new breed of mortgage emerged, the subprime loan. Mortgage lenders became less risk averse as other sources besides Fannie Mae and Freddie Mac popped up to buy mortgages on the secondary market. These buyers, often large investment houses, snapped up nonconforming loans, bundled them into securities, which they then sliced up and sold to other investors. As the pool of available mortgage money grew, lenders loosened their standards, going so far as to issue mortgages that required no income or asset verification. Easy money allowed more buyers to enter the market, driving up real estate values. By 2008, when it became apparent that many borrowers could not repay their loans, the market crashed. Even Fannie Mae and Freddie Mac got caught in the financial meltdown and were taken over by the government. Borrowers can still obtain conforming loans, but they must meet much more stringent standards.
Tighter Standards for Conforming Loans
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While in past years, a mid-credit score of 620 would have satisfied lenders, today it is much higher, though no exact figure is set in stone. Debt ratios can be as high as 45 percent of gross monthly income, provided the borrow can show sufficient savings in reserve.The down payment requirement is 10 percent of the purchase price; PMI (private mortgage insurance) is required when less than 20 percent is put down. The PMI companies have tightened up as well. Most require a 720 to 740 mid score to insure a loan. In some instances a borrower may satisfy conforming loan requirements, but not the PMI company. For example, conforming loans normally require borrowers to show two years of consistent employment, but exceptions may be granted depending on the cause of a gap. The PMI company, though, may reject the same borrower.
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