If you have a mortgage or are still looking to get one you’ve probably have heard about conforming and jumbo loans. But how much do you know? What distinguishes one from the other?

Read on because understanding the difference between the two could be one of the steps to making that big decision-the type of mortgage that best suits your needs.

Conforming loans Fannie Mae and Freddie Mac Guidelines

A conforming loan is a type of Jumbo loan that adheres to Fannie Mae & Freddie Mac’s underwriting guidelines in terms of income, assets and credit requirements. Fannie Mae & Freddie Mac are the pair that buys and scrutinizes mortgages in the market at the secondary level.

Also, for a loan to be considered as conforming, it must be below or at the loan (conforming) limit which is set by FHFA. Before 1st October, 2011, this amount limit was up to $729,750 in the regions of highest cost in the US but it went down to $625,000 as the maximum amount. The traditional limit for conforming is as low as $417,000. There has been a lot of changes in the conforming jumbo loan limit since the occurrence of the mortgage crisis.

Conforming loans have cheaper mortgage rates

The mortgage rates for conforming loans which are below or at $417,000 limit. Loans which amount between $417,001 and $625,500 (some circles call them conforming jumbo loans) have higher mortgage rates.

For loans which are exclusively jumbo, mortgage rates are even higher, depending on the loan type and the risk “appetite” of the issuing lender.

The difference is basically about the risk involved. Conforming jumbo loans being guaranteed by government-backed Fannie Mae & Freddie Mac enjoy more secondary market demand.

The result of this is much lower interest rates as the number of buyers guarantees a high price for the banks’ mortgages and hence lower yield.

Jumbo loans are generally higher priced

Since these loans do not meet the Fannie Mae & Freddie Mac standards, they don’t provide the coveted guarantee from the government. This makes the rates on this type of loans higher. The question of how high is answered depending on the market in question. Strong demand for jumbo loans from investors leads to a narrow spread and a weak demand leads to a wide spread. The financial crisis led to people seeking government guarantee before they could get a loan. This led to widening of the spread from the historical 0.25 to 0.5 for each percentage point up to 2 for each percentage point.

Currently, jumbo loans and conforming loans have a spread which is less than half for each percentage point.

Jumbo loans might be more difficult to get

There is also more difficulty in qualifying for a jumbo than a conforming loan. This is because fewer banks and lenders offer the former than the latter. This leads to higher rates of interest and more restrictions on the basis of finance when it comes to obtaining a jumbo loan.

For instance, you might be required to have a large down payment (sometimes even up to 20% or higher). Another restricting requirement might also be ownership of many assets.

Summary

Your choices for a loan program may also be significantly limited when you want to obtain a jumbo loan, although ARM and fixed-rate options are often available. These drawbacks are probably why many homebuyers do not like going into the territory of jumbo loans. However, as you seek a mortgage loan, be sure to contact various lenders so that you can explore all the options you have: jumbo, conforming or anywhere else.