Conforming mortgages are loans that meet Fannie Mae and Freddie Mac guidelines. Mortgages that do not meet these guidelines are often referred to as Jumbo Loans. The guidelines include criteria for the loan to value ratio, the credit score and debt-to-income requirement of the borrower, and the dollar amount of the loan. Conforming mortgages cannot exceed $417,000 on single-family houses, except for in specific counties outlined in recent legislation where property values are higher.
The reason that these guidelines are important is that conforming loans can be resold to Freddie Mac and Fannie Mae and jumbo loans cannot. Conforming loans have lower interest rates. It is very advantageous for lenders to be able to resell the mortgages to Freddie Mac and Fannie Mae, as it frees up their funds and allows them to originate more mortgages. Freddie Mac and Fannie Mae purchase mortgages from savings and loans, banks and other lenders and then package them together and offer securities for sale to investors. The proceeds from the sales are then used to purchase more mortgages.
Because jumbo loans cannot be purchased by Freddie Mac and Fannie Mae, lenders must either carry these mortgages on their books or find private investors or investment groups to purchase them. These loans are higher risk for lenders than conforming loans and therefore come with higher interest rates. In the past, large investors like Merrill Lynch and Citicorp purchased these jumbo loans in the form of mortgage-backed securities which were then sold to hedge funds, pension plans and other institutional investors. However, these opportunities are practically non-existent in today’s financial climate. In most circumstances, lenders must carry these loans on their books and therefore are not originating as many jumbo loans.
Due to the tightening credit conditions, it is very important for borrowers to meet the established criteria set forth in the guidelines issued by Freddie Mac and Fannie Mae. Borrowers with poor credit and high debt-to-income ratios may not always qualify for conforming loans. In these circumstances the borrowers may be forced to seek a loan from portfolio lenders. Portfolio lenders do not sell their loans in the secondary market. They are high risk loans and carry high interest rates. The difference in interest rates between conforming and jumbo loans has widened during the recent financial crisis and tightening credit conditions. The federal government has recently passed legislation to help borrowers in areas where home values are high so that they can meet the loan amount criteria for conforming loans.