Mortgage 101: Conforming vs Non-Conforming (Jumbo) Loans
There are several different types of mortgage loans that may be appropriate for you when you want to buy a house. If you’re feeling confused about your options, it may be helpful to look at some of them in more detail.
The price of the home you want to buy can have a lot to do with the type of mortgage you need. At SIRVA Mortgage, we get a lot of questions about conforming vs non-conforming loans and the differences between them. Here are the things you need to know before you apply for a mortgage with us.
What is a Conforming Loan?
Let’s start with an overview of conforming loans. Simply stated, a conforming loan conforms to the standards set by the Federal Housing Finance Authority (FHFA). The FHFA was created under the Housing and Economic Recovery Act (HERA) of 2008, which was enacted in response to the 2007-2008 housing and financial crisis.
The FHFA is responsible for the oversight, regulation, and supervision of Fannie Mae and Freddie Mac (The Agencies or “GSE’s”). Their mission is to ensure that these entities “serve as a reliable source of liquidity and funding for the housing finance market throughout the economic cycle.”
Part of what the FHFA does is to set limits for conforming loans which are – as the name suggests – loans that conform to the limits and standards of Fannie Mae and Freddie Mac. The limits are adjusted annually and are based on a formula that was established under HERA.
The 2021 conforming loan limit for most of the United States is $548,250. However, there are exceptions for high-cost markets. FHFA defines a high cost market as areas where 115% of the local median home value exceeds the regular conforming limit. The areas where exceptions exist have conforming loan limits based on the median home value. The highest conforming loan limit for 2021 is $822,375.
We should note here that the limits we have listed here are for single family homes and residences. There are higher limits for multiple-family homes. You can find a full list of the conforming loan limits on the FHFA website. Any loan that exceeds the conforming loan limit is considered a jumbo loan.
What is a Non-Conforming Loan?
A non-conforming loan is a home loan that does not conform to the standards of Fannie Mae or Freddie Mac. A non-conforming loan may be referred to as a jumbo loan or even as a super jumbo loan in some cases. There are several important differences for borrowers to remember when comparing a jumbo vs conforming loan.
The first is borrowing flexibility. With a conforming loan, you'll be required to adhere to the conforming mortgage limits set by the FHFA. Jumbo loans have more loan size flexibility and are intended to allow people to buy higher-priced homes. Each lender has the option of setting minimum down payment requirements and a maximum loan limit for the amount they will lend with a jumbo loan.
The second key difference is that when you apply for a jumbo mortgage loan, you will be met with stricter underwriting requirements than you would with a mortgage backed by Fannie Mae or Freddie Mac. The stricter underwriting guidelines translate to greater scrutiny of your credit report and credit history and higher credit score requirements. The scrutiny occurs because lenders who offer non-conforming loans take on more risk by lending larger amounts.
As a borrower, you have many options when it comes to finding a lender for a jumbo loan. Traditional banks, credit unions, and specialty mortgage lenders such as SIRVA Mortgage all offer jumbo loans to qualified borrowers.
Challenges of Non-Conforming Loans
If the loan limit for a conforming loan does not meet your needs, then you may want to consider a non-conforming loan. However, it's essential to understand the challenges of non-conforming loans since the requirements may be different from what you have encountered with a conforming loan.
Reliance on Variable Sources of Income
It's common for jumbo loan borrowers to rely on more unconventional sources of income. Some examples include income from self-employment, partnership income, as well as stock options and bonuses.
You should be prepared to verify these sources of income by providing financial statements, stock/mutual fund statements or tax returns.
Many jumbo lenders require copies of your most recent two year federal tax returns to show consistent income. When you provide your returns, be sure to include copies of all related documents, including W-2 and 1099 forms and any other forms filed with your 1040.
Verification of Down Payment Funds and Cash Reserves
For a jumbo loan, financial liquidity is an important consideration. You should expect that a lender will take into account the portion of your liquid assets that will be remaining after closing to meet cash reserve requirements. The cash reserve requirements can vary from lender to lender. Their purpose is to reassure the lender that you'll be able to make your mortgage payment even if you come into financial hardships.
In most cases, your mortgage lender will expect a significant down payment when you buy a house using a jumbo home loan. A 20% down payment is most favorable for a jumbo loan. The requirement is more nuanced than that generalization, however 20% down may help you to get more favorable interest rates than you would get with a smaller down payment.
Whatever the size of your down payment, jumbo lenders will need to verify that you have the funds to make the required down payment and have sufficient cash reserves. Whether your funds are in a bank account, mutual fund, stock account or any other liquid account, statements to show the funds have been in the accounts for at least two months will be required.
Stricter Requirements for Financial Metrics
The most common metrics used to determine a borrower’s ability to fulfill the obligations of a mortgage loan are the FICO scores and debt-to-income ratio (DTI).
While FICO scores for FHA and VA loans can be as low as 500, jumbo lenders generally require higher scores. Requirements can vary from between lenders but it’s a good rule of thumb that you’ll need a minimum score of 680 and if you have an even higher score, you’ll have a better chance of being approved for a non-conforming loan.
In terms of your DTI, a lower percentage of debt to income will work in your favor. Generally you can expect the maximum acceptable ratio to be 43% for a jumbo loan.
Depending on the purchase price of your home, it’s possible that your jumbo mortgage lender will want to see two appraisals of the property you plan to buy. Two appraisals will likely be required for purchases over one million. The request for a second appraisal is something that should give you and your lender assurance that you are not overpaying for the home.
Remember, a lender’s primary concern is your ability to make on-time monthly mortgage payments – and if you default, to have confidence they can recoup their money by selling the property. Agreement between two appraisals means that the property’s purchase price is in line with the actual market value.
Which Loan Type is Right for You?
You may be wondering whether a conforming or non-conforming loan is right for you. To help you decide, let’s look at the benefits of each type of loan.
Conforming loans offer the benefit of more relaxed loan and underwriting requirements designed to remove obstacles and allow people with imperfect credit to achieve their dream of owning a home. That means that requirements for credit scores, DTI, and down payments are more likely within your reach.
Conforming loan lenders have the option of selling the loans to Fannie Mae or Freddie Mac. For that reason, it’s sometimes possible to get a lower interest rate and more favorable terms with a conforming loan because the lender has some protection.
It’s also worth noting that some borrowers with conforming loans received help during the COVID-19 pandemic in the form of a federal moratorium on foreclosures. For loans held by Fannie Mae or Freddie Mac, loss mitigation was also a likely possibility. For people who lost their jobs, the moratorium and other options provided some peace of mind at a difficult time.
The downside of a conforming loan is that you’ll be limited in terms of how much you can borrow and possibly on where you can buy based on the amount you need to borrow.
The advantages to non-conforming loans include the more flexible lending limits that can be useful if you want to buy in a high-priced area or you’re interested in a luxury home.
The primary drawback of a jumbo loan is that your lender can’t sell the loan to Fannie Mae or Freddie Mac. That makes their risk higher and some lenders charge higher interest rates to make up for their increased risk. We already mentioned the more rigorous application and underwriting process and you should keep that in mind as well.
Ultimately, the best loan for you is one for which you can qualify and allows you to buy the home you want. You may need to research multiple lenders and compare costs before choosing the option that’s best suited to your needs.
Both conforming and non-conforming loans have their benefits and drawbacks. Before you begin the mortgage application process, it’s important to educate yourself about the differences and be prepared to compare rates and benefits before you buy a home.
Do you need some help comparing loan types and buying a home? SIRVA Mortgage is here to help!