What is … A Conventional/Conforming Mortgage Loan?

Conventional Mortgage Loans

One of the most fundamental, but frequently-asked questions, that I receive from new mortgage professionals is to explain the meaning of “conventional” and “conforming” mortgage loans.  The answer is relatively straightforward.

In order to be considered a “conventional” mortgage loan, the loan would have to be purchased, backed, or securitized by a non-purely-governmental entity.  The money to fund a mortgage loan obviously has to come from somewhere.  Mortgages are typically funded by either:

• Portfolio lenders who use their own funds, retain ownership of the loans that they originate, earn all of the interest generated from the loans that they originate, are able to establish and utilize their own underwriting parameters when originating these loans, incur all of the risks associated with these loans, and retain the liability on their balance sheets during these loans’ terms; or
• Lenders who close loans with their own or others’ funds and then sell those loans to third-party investors shortly after closing.

When a lender originates a residential mortgage loan with the intention of selling it to a private investor, the investor defines the underwriting parameters under which the loan must be originated.  When the investor is not a purely-governmental entity, the loan that it buys is considered to be conventional.

In addition to private investors, Government Sponsored Enterprises (GSEs) fund, buy, securitize, and guarantee residential mortgage loans.  In fact, most American mortgage loans are securitized through one of these three GSEs:

1. The Federal National Mortgage Association (Fannie Mae – FNMA);
2. The Federal Home Loan Mortgage Corporation (Freddie Mac – FHLMC); and
3. The Government National Mortgage Association (Ginnie Mae – GNMA).

Contrary to popular belief, Fannie Mae and Freddie Mac are not purely-governmental entities.  Fannie Mae and Freddie Mac are actually shareholder owned.  One cannot buy shares of stock ownership in a purely-governmental entity.

As previously discussed, when a lender originates a mortgage loan that is intended to remain in portfolio, that loan is underwritten based upon that lender’s underwriting criteria.  When a lender originates a mortgage loan that’s intended for sale to a private investor, that loan must be originated based upon the underwriting parameters as established by that private investor.  Similarly, when a lender originates a mortgage loan that’s intended for sale to Fannie Mae or Freddie Mac, that loan must be underwritten based upon Fannie Mae’s or Freddie Mac’s underwriting parameters.  Since portfolio lenders, private investors, FNMA, and FHLMC are not purely-governmental entities, the loans that they originate, purchase, and securitize are considered to be “conventional” loans.

The Government National Mortgage Association (GNMA) is the only purely-governmental entity that securitizes residential mortgage loans.  GNMA is responsible for the securitization of the three types of residential government loans securing properties located throughout the United States and its possessions:

1. FHA;
2. VA; and
3. USDA.

Any loan that is securitized through GNMA, therefore, is classified as a government, also referred to as a non-conventional, mortgage loan.

Conforming Mortgage Loans

Every year, the Federal Housing Finance Agency (FHFA) defines mortgage loan limits based on the four types of residential property usage:

1. Single-family residences (SFRs);
2. Two-family residences (2Fams);
3. Three-family residences (3Fams); and
4. Four-family residences (4Fams).

The FHFA-established annual loan limits take effect for all residential mortgage loans originated each year on and after January 1st.

A residential mortgage loan deemed to be “conforming” must “conform” to two standards:

1. The loan must adhere to Fannie Mae’s or Freddie Mac’s underwriting parameters; and
2. The original loan balance must be no higher than FHFA-established annual loan limits.

If a loan does not conform to either Fannie Mae’s or Freddie Mac’s underwriting parameters and/or FHFA-established annual loan limits, the loan is classified as “non-conforming.”

Conventional loans can be both conforming and non-conforming.

A conventional/conforming mortgage loan would be a loan that is purchased, backed, or securitized by a non-purely-governmental entity, adheres to FNMA or FHLMC underwriting parameters, and falls within FHFA-established annual loan limits.

A conventional/non-conforming mortgage loan, therefore, would be any loan that is purchased, backed, or securitized by a non-purely-governmental entity while failing to conform to either FNMA or FHMLC underwriting parameters and/or FHFA-established annual loan limits.

A non-conventional/non-conforming loan would constitute any of the three government loans.  This is because a government loan would never conform to FNMA or FHLMC underwriting parameters even if it conforms to FHFA-established loan limits.

Lastly, there is no such mortgage as a non-conventional/conforming mortgage loan.

So with that, I hope that you now and more clearly understand conventional/non-conventional and conforming/non-conforming residential mortgage loans.