Pros and Cons of Conforming Loans

Quick Answer

Conforming loans are the most common type of mortgage loan, primarily because they adhere to government-set guidelines that benefit lenders and borrowers alike. But there are downsides, too, including lower borrowing limits and stricter loan criteria.

Young couple and real estate Financial Advising agent using laptop and notes to weight the pros and cons of conforming loans.

If you're reviewing your mortgage loan options, you'll likely encounter conforming loans, the most common type of home loan. Conforming loans have loan limits set by the government, and they adhere to the borrowing guidelines of Fannie Mae or Freddie Mac, two government-backed mortgage companies that own many residential mortgages in the United States.

Conforming loans are considered the standard in a competitive lending marketplace, so it makes sense to weigh them among your financing choices. However, it's essential to know all the pros and cons before committing to a conforming loan.

What Is a Conforming Loan?

A conforming loan is a type of conventional loan that adheres to the maximum loan limits established by the Federal Housing Finance Agency (FHFA) and also meets the lending criteria of Fannie Mae and Freddie Mac.

These enterprises package and sell conforming loans on the secondary markets like stocks. With the ability to sell your mortgage to Fannie Mae or Freddie Mac, your lender essentially has a guarantee on your loan. As such, these loans generally come with lower interest rates and more favorable terms than non-conforming loans.

Conforming loan limits for 2023 are $726,000 for single-unit properties. In high-cost areas, the maximum loan amount increases to $1,089.300 for one-unit properties. You can use the FHFA's conforming loan limit map to determine the loan limit in your county.

You may qualify for a conforming loan provided you meet the following criteria:

  • Minimum FICO® Score of 620: Your FICO® Score is the credit score used by 90% of top lenders.
  • Down payment of 3% or more: While 3% is the minimum, you should ideally aim for a down payment of at least 20% to avoid paying property mortgage insurance (PMI).
  • Debt-to-income ratio (DTI) of 45% or less: You may qualify with a ratio as high as 50% with a higher credit score or down payment.
  • Appropriate loan amount: Your loan amount must fall below Fannie Mae or Freddie Mac caps.

Conforming loans and non-conforming loans are types of conventional loans. If the loan amount you seek exceeds conforming loan limits, your loan will fall into the non-conforming category. With a larger loan amount at risk, lenders may impose stricter lending criteria and higher interest rates.

Pros of Conforming Loans

Your budget, credit score and unique financial circumstances will significantly influence whether you should take out a conforming loan, but here are some ways you might benefit from a conforming loan.

Less Stringent Lending Requirements

Generally, you may qualify for a conforming loan more easily than a non-conforming one. For starters, lenders usually require a minimum credit score of 620 for conforming loans. But if you want to buy a more expensive home, you'll need to take out a non-conforming jumbo loan with a minimum credit score of 700.

Conforming loans require a minimum down payment as low as 3% with good credit, which is often lower than down payment requirements for non-conforming loans. For example, FHA loans require down payments as low as 3.5% if your credit score is at least 650.

You may also qualify for a conforming loan with a debt-to-income ratio as high as 50%. By contrast, you'll typically need a DTI below 36% to qualify for a jumbo mortgage loan.

Possible Lower Interest Rates

To compensate for the additional risk associated with non-conforming loans, lenders often increase interest rates by 1 or 2 percentage points on jumbo loans. Your lender will also consider your credit score, income, assets and other financial metrics to determine the interest rate on your mortgage.

Loan May Process Faster

Underwriting is the process of verifying your income, debts, assets and property details to help your lender determine whether to approve your loan. Since Fannie Mae and Freddie Mac guidelines are quite standardized, you likely won't run into irregular lender requirements that could hinder the process.

Possible Loan Protections

Conforming loan lenders must comply with the Truth in Lending Act and other legislation that protects consumers against predatory or unfair lending practices. For example, homeowners with loans owned by Freddie Mac who experienced Covid-related financial difficulties could qualify for up to 18 months of forbearance and have penalties and late fees waived, among other benefits.

Cons of Conforming Loans

Although conforming loans are the most common type of mortgage loan and can offer favorable rates and terms, they may not be your best option. Before proceeding, consider these potential downsides.

Lower Borrowing Limit

Conforming loans cap financing at $726,000 for single-unit properties but extend the limit to $1,089,300 in certain high-priced regions. If you need more than these FHFA limits allow, you must secure a non-conforming jumbo loan.

Stricter Loan Criteria

In some cases, conforming loans have more stringent lending requirements. For example, the minimum credit score for conforming loans is 620, but if your score falls below that threshold, you might consider an FHA loan which requires a minimum score of just 500. Be aware, however, this option requires a down payment of at least 10%.

Potential for Private Mortgage Insurance

While you may qualify for a minimum down payment of only 3%, you could have to pay PMI if you put down less than 20%. Similarly, you could have to pay mortgage insurance with a government-backed loan, such as FHA or USDA loans.

PMI costs typically range from 0.22% to 2.25% of your mortgage amount. The amount you pay for PMI depends on your credit score and total loan amount. Ask your lender to specify the percentage that would apply in your situation so you can make accurate calculations.

Get Your Credit Mortgage-Ready

Before applying for a conforming loan or any other type of mortgage, consider improving your credit to help your odds of loan approval and with lower interest rates. Start by reducing your debt and paying your bills on time each month. It's also essential to avoid making large purchases with credit in the months before you plan to apply for a mortgage. Additionally, don't apply for new credit since the inquiry could temporarily ding your credit score by five points or less.

It's also wise to get a free copy of your credit report and FICO® Score to see where your credit stands. Review your credit report to ensure there's nothing that could hurt your chances of approval. By shaping up your credit before applying, you can improve your chances of loan approval with more affordable loan terms.