What is a Conforming Loan ? Part # 1

By Dian Hymer

Part 1 - Part 2 - Summary

You may have noticed when you last shopped for mortgage rates that most lenders make a distinction between conforming and jumbo loans. The interest rate quoted on a conforming loan is usually 1/4 to 1/2 percent less than it is on a jumbo mortgage from the same lender.

A conforming mortgage is one that is packaged for resale on the secondary mortgage market to Fannie Mae or Freddie Mac, two quasi-governmental agencies that buy mortgages from cooperating lenders. Both agencies set limits annually on the size loans they'll buy. In 1999, the conforming loan limit was increased to $240,000 from $227,150 in 1998.

Conforming loans not only have the most competitive interest rates, they also tend to have the most stringent qualifying criteria. If your credit is shaky or you have been job-hopping in recent years, you may find it easier to qualify for a mortgage with a portfolio lender. A portfolio lender is a lender that doesn't routinely sell its loans on the secondary market. You may pay a higher interest rate with a portfolio lender, however.

To keep financing costs down, some home buyers put enough cash down when they purchase their home to keep the mortgage amount within the $240,000 loan conforming limit. But, for many buyers in expensive markets like Los Angeles, San Francisco or Boston, it's hard to come up with enough cash to make up the difference between the purchase price and the conforming loan limit.

First Time Tip: One way to bridge the gap between the conforming limit and a high purchase price--without resorting to a jumbo loan--is to use a combination of a first and second mortgage (often called "piggy-back" financing). Let's say that you're buying a home for $350,000 and you have enough cash for a 20 percent down payment of $70,000. This leaves $280,000 that must be financed. If you take out a conforming loan for $240,000, this leaves $40,000 that can be financed in the form of a second loan.

You'll pay a higher interest rate on a second mortgage than you will on a first mortgage. Currently, interest rates on seconds are running about 1 3/4 percent higher than they are on conforming mortgages. So, if the rate you're quoted on a new first mortgage is 7 percent, the rate on the second might be 8 3/4.

The monthly payments on second mortgages from institutional lenders are amortized over either 15 or 30 years. In both cases the loans are usually due in 15 years. If you go with the 30-year amortization schedule, you'll have to make a balloon payment in 15 years, if you haven't sold the home or refinanced by then. A balloon payment is a final payment that is significantly larger than the monthly payment. A loan that's amortized over 15 years will be paid in full at the end of 15 years.

A loan that's amortized over 15 years will have higher monthly payments than a loan that has a 30-year amortization. Higher monthly payments make it harder to qualify.

Piggy-back financing makes the most sense financially for buyers who intend to pay the second mortgage off early. For example, suppose you're selling another piece of property, but you won't have the proceeds from that sale before you close on the purchase of your new home. When the sale of the other property goes through, you can pay off the second mortgage and be left with a low-interest rate conforming first mortgage.

The Closing: Another option is to ask the seller to carry a second mortgage for you.