A lot of new terms get thrown at you on the purchasing journey, and one of them is conforming loan limits. Let’s dig into what that means and how it affects your ability to buy the home you want.
What is a conforming loan?
Fannie Mae and Freddie Mac are government-created enterprises that buy mortgages from lenders, thereby providing the lenders with more available money to issue more loans. This provides stability, liquidity and affordability to the mortgage market.
A conforming loan is a mortgage loan that meets the criteria needed to be bought by Fannie Mae or Freddie Mac. These loans differ from non-conforming loans like jumbo loans and loans backed by government entities like FHA, the VA, or USDA.
Perhaps the most significant requirement of a conforming loan deals with loan limits. Fannie and Freddie will only purchase loans under a certain amount, which may change every year depending on home prices.
A big benefit of a conforming loan for borrowers is that they usually offer a lower interest rate than non-conforming loans. This means a lower monthly payment for the homeowner, which can add up to thousands of dollars in savings over the life of the loan.
What are the qualifications of a conforming loan?
Since Fannie and Freddie are the entities purchasing the loan, they set the parameters that homeowners must meet to get approved. One of them is a minimum 620 credit score. They require a down payment of at least 3 percent, and a debt-to-income (DTI) ratio of 43 percent or less.
Let’s look at an example. If you make $120,000 per year ($10,000 a month of gross income) and want to purchase a $250,000 house, you would need to put at least $7,500, or 3 percent down. For your DTI ratio to be at 43 percent or lower, you couldn’t have more than $4,300 in debt payments, including your credit cards, vehicle payments, student loans, and any other monthly credit obligation. If you don’t have that much of a down payment, your credit score is lower, or your DTI ratio is above 43 percent, you would need to look into government-backed loans with more lenient standards.
Why are there limits, and why do borrowers need to pay attention to them?
You may hear conforming loan limits mentioned quite a bit during your mortgage journey, and with good reason. If you’re aiming for a conforming loan, you’ll need to stay within the limits they cover, or you’re going to have to go down a different financing path. The limit is the maximum Fannie and Freddie will purchase or guarantee.
The limits are decided by a formula that was created by the Housing and Economic Recovery Act, passed in 2008. The limit from the time the Act passed to 2016 was $417,000. Since then, they’ve been adjusted every year based on median home prices in the United States.
What about really expensive areas?
If you’re buying a home in a small town in Virginia, it will most likely cost much less than the same size house in Los Angeles. Conforming loans make allowances for this. Luckily, homebuyers who are purchasing houses in expensive areas of the country (like San Francisco, New York City and Washington, D.C.) may be able to qualify for a conforming loan that has higher limits. If home prices are higher than the median amount in a county, the maximum loan limits can be set higher, but will never go over 150 percent (base loan limit X 1.5) of the baseline.
What’s new in 2023 for conforming loan limits?
The Federal Housing Finance Agency (FHFA) announced the limit will be increased from $647,200 to $726,200 in 2023*. This is a 32% percent increase in only two years. The real estate market and home prices drove this move. The high-cost areas will have conforming loan limits of $1,089,300 (or 150 percent of the baseline, as mentioned above). The county by county limits are listed separately, here.
It’s smart to think about how you’re going to finance your new home at the beginning of your journey so you don’t run into unexpected problems. Being able to qualify and get approved for a conforming loan may allow you some distinct advantages, like lower interest rates. Let’s chat about your mortgage loan options to see if a conforming loan is the right fit for you.
* Effective for applications immediately (11/30/22)
