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Why Are Conventional Loans Called Conforming Loans?
Fannie Mae and Freddie Mac are the two largest purchasers of mortgage loans on the secondary market. However, there are buyers of mortgage loans on the secondary mortgage market who purchase mortgage loans from multiple smaller mortgage bankers.
Middle-level mortgage bankers will purchase mortgages from dozens of small to mid-sized lenders and package them up in bulks as mortgage-backed securities, often referred to as MBS.
The middle-level regional mortgage bankers will then sell the mortgage loans they purchase from smaller mortgage bankers and correspondent lenders and sell them to Fannie Mae or Freddie Mac. Fannie Mae and Freddie Mac will not purchase mortgage loans that do not conform to Fannie Mae or Freddie Mac Guidelines. This is why conventional loans are called conforming loans.
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2 Replies
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Conventional loans are referred to as conforming loans because they conform to the guidelines set by government-sponsored enterprises (GSEs) such as Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). These guidelines typically include criteria like loan amount limits, borrower credit scores, debt-to-income ratios, and documentation requirements.
When a loan adheres to these guidelines, it is considered conforming, meaning it meets the standards set forth by these entities. Conforming loans are often seen as less risky for lenders because they meet these standardized criteria, making them easier to sell on the secondary mortgage market. This marketability provides liquidity to the mortgage industry, allowing lenders to continue offering loans to borrowers.
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Conforming loans are mortgage loans that adhere to the guidelines set by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. These guidelines typically include loan amount limits, borrower credit requirements, and debt-to-income ratios, among other criteria.
The key characteristics of conforming loans include:
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Loan Limits: Conforming loans must fall within the loan limits set by Fannie Mae and Freddie Mac. These limits are revised annually and vary by location, typically reflecting the average home prices in the area.
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Credit Requirements: Borrowers need to meet certain credit score requirements to qualify for a conforming loan. Generally, a higher credit score indicates lower risk for the lender.
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Loan-to-Value (LTV) Ratio: Lenders assess the loan-to-value ratio, which compares the amount of the loan to the appraised value of the property. Lower LTV ratios are often preferred, as they signify less risk for the lender.
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Debt-to-Income (DTI) Ratio: Lenders evaluate a borrower’s debt-to-income ratio to ensure they have sufficient income to cover their mortgage payments along with other debts. A lower DTI ratio typically indicates lower risk for the lender.
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Mortgage Insurance: Conforming loans may require private mortgage insurance (PMI) if the borrower’s down payment is less than 20% of the home’s purchase price. PMI protects the lender in case the borrower defaults on the loan.
Conforming loans are attractive to borrowers because they often come with lower interest rates compared to non-conforming loans, which don’t meet the criteria set by Fannie Mae and Freddie Mac. This is because conforming loans are generally considered less risky for lenders due to their adherence to established guidelines.
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