Conforming and Jumbo Only Apply to "A Paper" Conventional Financing

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This is something that many folks don't understand about the loan market.

The labels "conforming", "jumbo" or, more accurately, "non-conforming" (and "temporary conforming" when we had it) only apply to so-called "A paper" loans, largely underwritten through Fannie Mae and Freddie Mac standards. The reasons for the labels are that they "conform" to Fannie and Freddie's requirements in all particulars, or that they conform in all respects except loan amount. But Loan to Value ratio, Debt to Income ratio, Time in Line of Work and everything else are according to the standards set down by Fannie and Freddie.

Government loans, VA and FHA, do not have conforming and Jumbo amounts. In the case of the VA loan, it's my understanding that they no longer have an explicit legal limit at all - just a limit on what lenders are willing to do given the limited nature of the guarantee. In the case of the FHA, there is a dollar limit, and it's usually even the same dollar limit at the upper bound as the temporary conforming limit. But to treat this as anything but a coincidence that saves brainwork on the part of the Department of Housing and Urban Development would be incorrect. In point of fact, the "regular" FHA limit is different from the conforming limit. Fannie and Freddie are now part of the government, but it's a different part than the FHA.

Subprime loans have none of this; only pricing and policy breakpoints, usually around $500,000, set by individual lenders.

So why is this such a big deal? You ask. Very simply, conforming loans get the best
tradeoff between rate and cost - what laymen think of as the best rates. It's an ambition worth having to have a conforming loan as opposed to anything else. The relationship between everything else varies over time, but you can expect sub-prime to have the highest rate/cost tradeoffs, while whether government beats non-conforming is time dependent. For about the past 18 months, government has been better, but back in 2003 for instance, non-conforming rates were generally lower than government - one more reason why government loans lost favor for several years. Conforming loans are also consistently available, and the government doesn't get involved. This was kind of a big deal several years ago when it could take four months for the government to process the paperwork needed for their loans. If I was told somebody wanted to buy my property with a government loan, there was quite a while there where I would have preferred another buyer.

Loans underwritten through Fannie and Freddie are also the most common sorts of loans out there, and they had the effect of standardizing the A paper market a couple decades back. When it was every lender for themselves, the standards varied by quite a bit. When they all want to sell to Fannie and Freddie, they all started using Fannie and Freddie's standards. Doing so meant they could loan the same money out several times per year, getting an origination bonus each time, rather than loan out the money and then only as it was repaid could they book the income. They could make far more money originating the loan and selling it to Fannie and Freddie than they could by actually holding it in their own portfolio. So-called "portfolio loans" still exist - large amounts of non-conforming loans end up being portfolio loans, which is one reason why they carry higher rates. When there's a ready, standardized secondary market for loan notes, and lenders can "turn" the money several times per year, they're willing to do the loans for less, which is a win for everybody.

Caveat Emptor

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About this Entry

This page contains a single entry by Dan Melson published on February 1, 2021 7:00 AM.

Demands Listing Agents Make That Aren't in Their Clients Best Interest was the previous entry in this blog.

Credit Reports: What They Are and How They Work is the next entry in this blog.

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