There are two types of conforming loans, conforming and high balance conforming. The vast majority of residential mortgages issued today are conforming loans and so-called because they conform to underwriting guidelines established by Fannie Mae and Freddie Mac. This is important to the housing industry because approving a loan using either Fannie or Freddie’s standards allows a lender to sell the loan into the secondary market. A mortgage company operates with a line of credit.
Each time a loan is funded, the lender taps into its credit line to fund the mortgage and then turn around and sell the loan which in turn replenishes the credit line. Lenders can make money over the loan term with a mortgage by collecting interest every month or sell it almost immediately when the loan is made. Most lenders even commit the loan for sale before the loan is finalized. Without the ability to sell a loan the lending industry would essentially dry up.
Conforming loans also have maximum loan limits set by Fannie and Freddie. These limits can change each year and most often do. The maximum conforming loan limit for most parts of the country is $484,350. When a lender approves a loan using Fannie or Freddie guidelines and keeps the loan amount at or below this number, the lender can provide their most competitive rates. But in some parts of the country, property values are much higher than in other areas. So high that the median home value exceeds the $484,350 amount and a standard conforming loan won’t work. In these areas, it’s possible to obtain a high balance conforming loan if the area has been designated as high cost. If the home is located in a high cost area, the maximum conforming loan amount can be much higher, as high as $726,525 and still be considered for sale in the secondary markets.
If a loan exceeds the conforming limit in either areas, it is then considered a jumbo. A $500,000 loan amount would be a jumbo loan in most parts of the country because it exceeds $484,350 but would not be considered a jumbo if located in a high cost area. The differences between a conforming, high balance and a jumbo primarily is addressed in the rates for each program. A conforming loan will have the lower of the three with a high balance right behind it. A jumbo loan will have the highest rates of the three. However, even though jumbo rates will be higher they won’t be higher by very much. Today, the variance between a conforming and a jumbo loan is somewhere near 0.375% to 0.50% with high balance loans falling in between this range.
Jumbo loans have their own approval guidelines and there really is no robust secondary market in which to sell the loan as there are for conforming loans. When lenders set their rates for jumbo loans each day they must take that into consideration and is the primary reason why jumbo rates are a bit higher than conforming ones. For example, a jumbo loan will ask for a down payment of at least 20 or 25% of the sales price whereas conforming loans need a minimum down payment of just 5%. When a conforming loan amount is more than 80% of the value of the property there will be a need for private mortgage insurance, or PMI. In the jumbo market, there are no such PMI policies, hence the 80% loan limit.
Now let’s look at a jumbo loan in an area that is deemed high cost. If the buyers are looking at two different houses in a high cost area and one is listed for sale at $1.25 million and the other is a $900,000, they may opt to choose the less expensive home and take out a high balance loan. The interest rates will be slightly lower compared to a jumbo loan and the minimum down payment requirement is less.
But there are options and options which should be discussed with your loan officer. High balance conforming loans allow lenders to approve loans using more universal guidelines compared to more restrictive guidelines for jumbo loan amounts. If there is a choice, the lower down payment and better rates for a high balance loan would get the nod.