11/25/2019 | Casey Fleming – The conforming loan limit is something you might have heard about but never really fully understood. If you are buying a home, however, understanding what the limit is in your area and keeping your loan amount below that limit can save you tens – or even hundreds – of thousands of dollars over the life of your loan. Let’s take a close look at this.
Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac are the two government-sponsored entities whose purpose is to purchase pools of mortgages from lenders (like banks and mortgage companies) in order to provide liquidity to the lenders so they can make more loans to home buyers and homeowners.
How Fannie / Freddie Make Mortgages Affordable
Fannie and Freddie (collectively “The Agencies”) then sell securities (bonds) to institutional investors in order to build up their cash again to buy more mortgages. These bonds are secured by the payments on the mortgages in the pools. As loans are paid down (or paid off) the payments are sent to the bond holders to pay interest and retire the debt.
Importantly, these bonds are guaranteed by the full faith and credit of the U.S. Government. (Yes, that means taxpayers, and that means you and me.) Because the investor’s money is guaranteed, they are willing to accept a lower yield on their investment than, say, corporate bonds, where they might lose principal.
So, the Agencies can raise money very cheaply. They pass that savings on (mostly) to lenders in the form of lower interest rates. Lenders pass that savings on to you (mostly), in the form of lower mortgage rates than they could offer if they raised money from Wall Street.
Why Non-Conforming Loans are More Expensive
The Agencies don’t offer to buy just any mortgage, however. They have rules – pretty strict rules, actually. Borrowers must be credit-worthy, be able to document their income and assets, and there are limits on the size of the loans they will buy.
A loan that conforms to Agency guidelines (including the size of the loan) is called a conforming loan. Loans that don’t meet Agency guidelines are called non-conforming loans, and are often referred to as jumbo loans.
Jumbo loans are purchased by Wall Street investment banks or hedge funds, who raise money the same way the Agencies do. However, since the investor’s returns are not guaranteed, investors require a higher yield for these loans. That higher yield is passed on to the mortgage companies, and then to you. So, conforming loans are almost always less expensive than non-conforming loans.
The Conforming Loan Limit is Adjusted Every Year
Each year the Agencies review housing prices and on or about December 1 announce the new nationwide conforming loan limit. In 2009 the Agencies realized that the conforming loan limit was too low in high-cost area, so they created a formula to address that. In high-cost areas the “high-balance” conforming loan limit would be 125% of the median home price in a county. However, it would be limited to a second ceiling, the high-balance conforming loan limit.
Related: What is the conforming loan limit?
Related: 2020 Conforming Loan Limits
A Conforming Loan is Less Expensive Than A Jumbo Loan
Why this matters to you is that a conforming loan is less expensive than a jumbo loan. So, if you can keep your loan amount under the conforming loan limit (or the high-balance conforming loan limit, if that’s relevant) then you can save money.
Strategies to Use a Conforming Loan to Save Money
Let’s say you have a purchase price of $1,000,000. If you put 20% down you would need a loan of $800,000. Today (November 25, 2019) the high-balance conforming loan limit is $726,525, so you’re short. To avoid using a jumbo loan, you have three options:
- Negotiate the price down or look for a less expensive home. If you only have 20% to put down, you’d need to keep your purchase price under $908,000.
- If you have more cash, simply come up with a larger down payment; your target loan amount will be the high-balance conforming loan limit.
- Use two loan to buy the property. A common way to do this is the use a first mortgage at the high-balance conforming loan limit, and an equity line for the second mortgage. You get a very low interest rate on the majority of the debt, and the rest of it you can pay down quickly by making extra payments.
Alternatively, you could just use a jumbo loan and be done with it, or possibly refinance in a year or two when you owe less money and the conforming loan limit has been raised.
The important thing is that you should know what conforming loans are and whether or not you can use them to save money in the long run. Now you know.
This article represents the opinions of Casey Fleming, and not necessarily those of C2 Financial Corp. This analysis was prepared with the best information available at the time it was written. Neither Casey Fleming, nor C2 Financial Corp., have any magical insider information about bond markets, real estate markets or mortgage markets that would make economic projections any more reliable than any other source. No warranty is made that the outcome will reflect the projections in this article, and neither Casey Fleming nor C2 Financial Corp. are responsible for decisions that you make regarding your own choices about your real estate or mortgage or those of your clients.
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