Coming to Terms: Understand Conventional vs. Conforming Loan Types

By James Young on November 22, 2013
Coming to Terms: Understand Conventional vs. Conforming Loan Types

Maneuvering the maze of finances involved in the loan application process is tough enough without someone throwing a vocabulary quiz at you. Unfortunately, the terms tossed your way as you consider financing options for the home of your dreams can start to all sound alike.

Worse yet, it is not unusual for the media, websites or even real estate professionals to confuse the issue further by using terms interchangeably, like conventional vs. conforming loans, that aren’t actually synonymous.

So what is a home-buying newbie to do?

Mortgage Term Cheat Sheet

If you read our column on understanding the lingo surrounding interest rates, you have probably been happily anticipating the next loan lingo lesson. Even if you haven’t, here’s a primer to help you understand the difference between some of the more common mortgage loan terms as you identify your best options for home financing.

  • Fannie Mae. No, it isn’t the name of your long-lost aunt. Fannie Mae is actually the oft-used nickname for the Federal National Mortgage Association. Although a publicly traded company, this entity is government-sponsored and has been around since 1938. It purchases mortgage loans that lenders have made to home buyers on what is known as the secondary market, meaning investors purchasing from investors. In doing so, Fannie Mae frees up additional funds from banks, increasing the availability and affordability of mortgage loans for low- to moderate-income borrowers.
  • Freddie Mac. Freddie Mac is a bit like Fannie Mae’s cousin. Known more formerly as the Federal Home Loan Mortgage Company, it is like Fannie Mae in just about every way. The only real difference is the type of banks each entity works with. With both Fannie Mae and Freddie Mac, there are also limits on the size of the loan that can come into play. These are adjusted annually and can have regional differences..
  • VA Loan. As its name implies, these loans are for military veterans. The Department of Veterans Affairs doesn’t actually make loans to veterans buying a home for the first time, but it does establish rules that govern how other lenders make VA loans. It also insures VA loans against default. Minimum down payment for qualifying veterans is zero down, making this an attractive option for those who have served in the military.
  • FHA Loan. A Federal Housing Administration, or FHA, loan is insured by the government against default. Like the VA, the FHA does not itself make loans; it merely sets rules for those lenders qualifying to make FHA loans. With a minimum down payment of just 3.5 percent, FHA loans are popular with first-time home buyers and others with low-to-moderate income who are unable to pull together the larger down payment necessary for a conventional loan.
  • Conforming Loan. Conforming to what, you might ask? A mortgage loan that is “conforming” refers to one that is within the conforming loan limits set by Fannie Mae and Freddie Mac, currently at $417,000, while also conforming to the funding criteria of Freddie Mac and Fannie Mae. A nonconforming loan, then, would be a loan that does not meet these requirements. So-called “jumbo” mortgage loans would fall into the category of nonconforming loans.
  • Conventional Loan. This definition is simple: a mortgage loan that is not made or insured by the government is known as a conventional loan. That means by definition, a conventional loan may also be conforming, but not all conforming loans are conventional loans. Loans above the lending limits set by Fannie Mae and Freddie Mac are often called jumbo loans. The majority of conventional loans, however, follow the qualifying criteria that would make them conforming.

Go Ahead—Be Conventional

If you have an excellent credit history and are able to make a larger down payment, anywhere from 5 to 20 percent, choosing a conventional loan will usually snag you an attractive interest rate, while allowing you to avoid all the red tape. A higher down payment also means your home equity will build more quickly.

Nearly all conventional mortgages will have either adjustable or fixed interest rates. Fixed interest rate loans usually have a term of either 15 or 30 years, with the shorter-term loans generally boasting the best interest rates. Adjustable rate mortgages, or ARMs, fluctuate with the standard financial index, so your monthly payment will fluctuate as well.

Rates vs Fees

Despite the advantages of a conventional loan, however, you may need to show up at closing with a sizable amount of change, depending on your credit score and other factors. Origination fees, mortgage insurance, points, down payments and appraisal fees can quickly add up, so pay close attention to the details of your loan and not just the interest rate alone to avoid any surprises at closing.

 

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About James Young

My name is James Young- I love red wine, sailing, and playing guitar. I believe that everyday is truly a gift. I'm blessed to live five minutes from the sand in the beautiful city of Long Beach, CA. When I'm not assisting homeowners, you'll find me belting melodies with friends around a campfire, wandering the halls of an art exhibit, or watching ESPN re-runs until the sun comes up. So what am I doing here, you might ask? In a couple of sentences- I'm passionate about empowering first-time and experienced home buyers to make their dreams a reality. Whether it's saving thousands on your home loan, buying your first home, or acquiring your first investment property, I'm always here to help. Don't hesitate to ask questions, and please remember to "share the love"! :) #loveloans #loverealestate #lovelife!