Conforming Home Loans: Definition & Basic Requirements

Reader question: "What is a conforming home loan, and how is it different from other types of mortgages? Is it the same as a conventional loan? Which ones are easier to qualify for, for a first-time home buyer like myself? I'm hopelessly confused by all of the lingo."

You've come to the right place. De-confusing home buyers is what we do! And if it's any consolation, you're certainly not alone. Many first-time buyers are confused by the conventional and conforming loan terminology.

Let's start by addressing your first and primary question: What is a conforming loan?

Definition of a Conforming Home Loan

To "conform" is to act in accordance with established rules, patterns or guidelines. In the case of a conforming mortgage loan, the rules and guidelines are promulgated by Fannie Mae and Freddie Mac. So here we have a definition forming:

Fannie Mae and Freddie Mac

As a borrower, you could go through the entire mortgage application and underwriting process without knowing anything about Fannie Mae or Freddie Mac. But they still affect your ability to get approved for a loan.

These two organizations, along with the Federal Housing Finance Agency (FHFA), establish the minimum acceptable criteria for home loans in the United States. If you meet these minimum criteria, you have a good chance of getting approved for a conforming loan.

Fannie and Freddie work in the "background" of the lending industry. They are not mortgage lenders. They are mortgage buyers and sellers. They operate within the secondary market, buying loans from lenders and selling them to investors on Wall Street.

When lenders originate mortgages, they typically do it in a way that makes the loan sellable to Fannie Mae and Freddie Mac. So here we have a second definition of a conforming loan. It's a mortgage that meets the minimum requirements needed to be sold into the secondary market.

Basic Requirements for a Conforming Mortgage

The Federal Housing Finance Agency (FHFA) establishes the guidelines and criteria for conforming loans. They determine which mortgages can be sold to Fannie Mae and Freddie Mac, and which ones cannot be sold to these organizations. So it's the FHFA that creates the official definition of a conforming home loan.

There are several criteria that make up a conforming mortgage. For instance, lenders must evaluate a borrower's debt-to-income ratio to ensure that he or she meets the minimum standards set forth by the FHFA, Freddie Mac and Fannie Mae.

Most lenders today limit borrowers to a debt-to-income (DTI) ratio of 28% on the front end, and 36% on the back end. This means the borrower's monthly housing expense should use up no more than 28% of his/her gross monthly income. Additionally, the borrower's total debts, including the mortgage payment, should use no more than 36% of income. These criteria are often expressed as "28/36."

Conforming loans also have certain documentation requirements. For example, lenders must obtain and verify financial documents that show the borrower is able to repay the mortgage obligation. In other words, the lender must request enough paperwork to make sure the borrower can afford the loan.

These documents include (but are not limited to): w-2 forms for the past two years, recent pay stubs showing year-to-date earnings, tax returns for past two years, and credit reports.

There are size limits as well. In order to meet the definition of a conforming loan, the mortgage must not exceed certain dollar-amount limits. The current limit for much of the country is $417,000 for a single-family home.

For certain high-cost areas, such as San Francisco and Washington, D.C., the loan limits are higher to account for the higher housing costs. In such markets, the upper loan limit is typically $625,500 for a single-family home (and higher for multifamily housing). Anything above these limits is considered a jumbo loan.

So that answers your first question: What is a conforming loan? It's a mortgage that conforms to certain minimum criteria, making it sellable to Fannie Mae and Freddie Mac. Let's move on to talk about the differences between conforming and conventional loans.

Not the Same as 'Conventional'

First-time home buyers often confuse the terms "conventional" and "conforming," and sometimes use them interchangeably. But they are two different things entirely.

A conventional mortgage is one that is not insured or guaranteed by the federal government. This distinguishes it from government-backed programs and products, such as the FHA and VA loan programs. So a conventional, or non-government-backed, loan can be either conforming or non-conforming depending on whether or not it adheres to Fannie Mae and Freddie Mac guidelines.

A jumbo loan, for example, can be conventional (which means it is not insured or guaranteed by the federal government) but non-conforming due to its size.