If you’ve been looking into getting a home loan, you’ve probably been confronted with a lot of terminology that can make it challenging to determine what different types of loans entail and what is the best fit for your situation.
For many first-time and repeat homebuyers in New Jersey, conforming loans can be a better choice due to their high approval rates and lower interest rates.
But to understand why conforming home loans are beneficial, it’s important to get some clarity on what other types of loans are available. This article will briefly overview the different loans available and define some key terminology. By the end, you’ll be well-versed in this area!
What Is a Conforming Loan?
You might be surprised to find that there is more than one kind of loan you can get, and the focus of this article is to sing the praises of conforming loans in New Jersey.
The definition of conforming loans is a loan that meets the requirements (as in “conforms to”) of two government-sponsored entities in the mortgage space:
- Fannie Mae (FNMA): The Federal National Mortgage Association:
- Freddie Mac (FHLMC): The Federal Home Loan Mortgage Corporation
These organizations got their start in 1970 under the Emergency Home Finance Act. Their purpose was to serve the secondary mortgage market by helping banks, savings and loan associations, and other lenders increase their liquidity.
The way it works is that these organizations buy mortgages from the banks, freeing up cash so that banks can continue to issue loans. In turn, Fannie Mae and Freddie Mac collect monthly mortgage payments from the banks, take their cut, and then turn the profits over to their investors.
The rules for conforming loans are designed to protect both the borrower and the lender. By requiring a borrower to meet a narrow set of circumstances, conforming loans set homebuyers up for success.
There are five requirements for conforming home loans:
1. Loan Limits
The size of the loan is limited to $647,200, though this figure may be as high as $970,800 in pricier areas of the country. These limits serve to keep the size of the mortgage payments reasonable.
This requirement doesn’t mean that a homebuyer is restricted from purchasing a more expensive home. However, to qualify for the loan, they would need to have a larger down payment.
2. Credit Score
Borrowers must have a score of 620 or higher. This credit score falls within the “fair” range, which can be risky for lenders. The amount of risk is offset by the higher down payment requirements.
However, keep in mind that available interest rates are tied to credit scores, so you’ll want a credit score that is as high as possible to take advantage of the best rates.
3. Debt-to-Income Ratio
To ensure that homebuyers are not biting off more than they can chew, lenders scrutinize how much debt the prospective buyer has before issuing conforming loans. The maximum DTI in most situations is 36%, though sometimes you might see 43% from some lenders.
4. Down Payment
Generally, a lender will want to see at least a 20% down payment for a loan to meet the requirements for being conforming. There are exceptions to this rule, and you may still be able to get a conforming loan for just 3% down.
5. Loan-to-Value Ratio
This figure is tied to the down payment, and it reflects the relationship between the amount borrowed and the value of the home. Often, the required LTV is 80% or lower, but a conforming conventional loan may have an LTV as high as 95% to 97%.
What is Conforming Loan Versus a Conventional Loan?
All mortgage loans fall into one of two categories: government-backed loans and not government-backed loans. Conforming loans are backed by the government and adhere to rules set by the Federal Housing Finance Agency (abbreviated as FHFA) regarding loan amounts, property types, and repayment abilities based on income and credit score.
On the lender side, there are disclosure requirements pertaining to costs and other key points of information to protect borrowers.
The confusion between conventional and conforming loans exists because of the overlap. A conventional mortgage is an umbrella term that means any home loan not secured by the government. However, conventional loans can be backed by Freddie Mac and Fannie Mae. There are also government-backed loans through the FHA, VA, and USDA that are classified as a conforming mortgage.
To sum up the difference, you can think of it like this: all conforming loans are conventional, but not all conventional loans are conforming. Conventional loans include both conforming and jumbo loans. If you’re not familiar with the term, a jumbo loan is a mortgage amount over the conforming loan amounts discussed above.
5 Pros of Getting a Conforming Loan
When comparing the different types of loans available, most homebuyers opt for conforming loans, with this type of loan accounting for 75% of active mortgages for single-family homes.
There are several benefits of getting a conforming loan, including these top five:
1. It’s Easier to Get Approved
The requirements for approval of a conforming mortgage are less strict than a jumbo loan. The security of being backed by the government and the more modest loan amounts give buyers an edge here.
2. You Can Get Lower Interest Rates
Conforming loans are known for having lower interest rates. Plus, the rates are fixed, so you don’t have to worry about fluctuating interest rates in an inflationary economy.
3. Consumers Are Protected
Pre-2008, some lenders had a reputation for being sneaky. They pushed novice buyers into homes they couldn’t afford and hid pertinent, life-altering terms in the fine print. With conforming loans, there are strict practices lenders must here to protect homebuyers.
4. You Can Avoid Paying for Costly Insurance
Homebuyers with a smaller down payment are required to purchase private mortgage insurance (PMI for short). Typically, PMI costs anywhere from 0.2% to 2.0% of the loan amount to be paid annually. By having a down payment of 20% or higher combined with a conforming loan, you can avoid this extra fee.
5. You Have Flexibility with How You Use the Property
You can get a conforming loan and then use the residence as a secondary vacation residence. Or, rent the property to someone else and collect investment income. Either way, conforming loans give you the option to be flexible.
Learn More about Conforming Loans in New Jersey
Cornerstone Capital was founded in the wake of the financial crisis, and we’ve been on a mission to help home buyers in New Jersey navigate the entire home buying process through education and one-on-one guidance. We encourage you to get in touch with us to ask questions or discuss your goals.