Higher Limits for Conforming & FHA Loans Could Make a Home Purchase More Affordable
Last month, I talked about how high housing prices, unpredictable and rising mortgage rates, combined with runaway inflation were making it tough for consumers to buy homes. In making suggestions for ways that might help consumers make buying a home more affordable, one of the ideas was to investigate the recent changes in “conforming loan” limitations.
The two most important federal entities that regulate mortgages — the Federal Housing Finance Agency (FHFA) and the Federal Housing Administration (FHA) — raised the confirming loan limits and FHA loan limits for 2023.
What is a “conforming loan?” This means a loan that is structured according to guidelines set by government-sponsored entities such as Freddie Mac and Fannie Mae, as well as the FHFA.
Contrast this with a “conventional” loan., which is any loan issued by a private, non-government entity, such as a bank. Not every conventional loan is a conforming loan. Conventional loans tend to require a larger down payment and charge higher interest rates than conforming loans.
A conforming loan is easier to qualify for. Conforming loans are also designed to be purchased by Fannie Mae or Freddie Mac on the secondary mortgage market, making them more appealable for lenders to offer them. And don’t think these loan programs are just for first-time home buyers – if the house you are looking to purchase is in a “designated low-cost area” (and Southern Cook County certainly is!), you can qualify for a lower interest rate.
Conforming loan limits are based on the average home price of an area and change each year to reflect current home values. Homebuyers shopping for a single-family homewill be able to qualify for a confirming loan of up to $726,200 in 2023, a $79,000 jump over the 2022 conforming loan limit.
For the consumer who is trying to figure out how to buy that bigger, fancier house, this increase is a boon. When the conforming limit price is passed, the only loan a purchaser can get is a “jumbo” loan, with a much higher down payment and interest rate. The new limits allow for an additional $79K before that line is crossed. In desirable areas, this could be the difference for the family that needs more bedrooms.
The FHA loan limits have also increased. FHA loans are traditionally meant for homes on the less-expensive side of the spectrum for lower income buyers. The FHA loan limit is set at 65% of the conforming loan limit. The 2023 FHA loan limit is now $472, 200.00, which is $51K higher than 2022.
So what’s the difference here?
FHA loans are issued by private mortgage lenders but are guaranteed by the government. This government backing classifies FHA loans as non-conventional, but it also makes the loans less risky for banks. As a result, it’s usually easier for borrowers to qualify for an FHA loan than for a conventional or conforming loan. If you have issues with your credit, it’s easier to get an FHA loan.
Conventional loans fall into two categories: Conforming and non-conforming loans. Loans that don’t meet the FHFA’s standards are considered non-conforming conventional loans – like the “jumbo” loans mentioned above.
The difference between conforming conventional loans and FHA loans, are the conforming loans are not backed by the government, but they meet the standards set by the FHFA and can be sold by your lender on the secondary market. So, while conventional conforming loans have fewer restrictions, they can still be tougher to qualify for.
The practical differences between FHA loans and conventional conforming loans are that with FHA loans, the home must be owner occupied. The down payment for the FHA loan tends is usually around 3.5% of the price, while conventional conforming loans usually require 5%. (Although there can be rara occasions where the conventional loan’s interest rate could be as low as 5%). Both loans require mortgage insurance, and with the conventional loan, this is eliminated when your debt-to-equity ratio reaches 20%. (Many FHA borrowers try to refinance when they get to that 20% level as well). Of course, the required minimum credit score is lower for the FHA loan.
In the end, there are multiple factors that every buyer needs to consider as they determine what kind of mortgage to pursue. Buyers need to determine how much they can ultimately spend on a house. Interest rates and the kind of loan you end up getting are just two of the factors. If people expect the interest rates to come back down to 2 percent again, they will be waiting a long time. But the costs of renting are at an all-time high as well. While the increased interest rates and rising prices force some to sit on the sidelines for now, those who want or need to buy despite the economic situation need whatever help they can get. Understanding mortgage options – like the “ins and outs” of conforming and FHA loan limits — is a great starting point.