A non-conforming home loan is a mortgage that does not meet the requirements set by Fannie Mae or Freddie Mac. These government-sponsored enterprises (GSEs) have guidelines for the loans they will purchase, including maximum loan amounts, loan-to-value ratios, debt-to-income ratios, credit history requirements, and eligible properties. Loans that fall outside of these parameters are considered non-conforming.
Non-conforming loans are often necessary for borrowers who don’t fit the strict criteria for conforming loans. While they usually come with higher interest rates, non-conforming loans provide financing options for a wider range of homebuyers. Here’s a comprehensive guide on non-conforming home loans and how they work:
What is a Non-Conforming Loan?
A conforming loan adheres to the underwriting guidelines set by Fannie Mae and Freddie Mac These GSEs were established by Congress to provide liquidity and create stability in the mortgage market They do this by purchasing conforming loans from lenders, packaging them into mortgage-backed securities, and selling them to investors. This gives lenders capital to issue new mortgages.
Any loan that does not meet the conforming loan requirements is considered non-conforming, Reasons a loan may be classified as non-conforming include
- Loan amount exceeds conforming loan limits
- Down payment is less than 20%
- Debt-to-income ratio is higher than allowed
- Credit score or history doesn’t meet guidelines
- Property type makes loan ineligible
While conforming loans can be sold to Fannie Mae or Freddie Mac, non-conforming loans stay in the lenders’ portfolios or must be sold to private investors. This increases the risk for lenders, so they charge higher interest rates and fees for non-conforming loans.
How Do Non-Conforming Loans Work?
The process of applying for and obtaining a non-conforming home loan is similar to a conforming loan:
- Meet with lender to discuss financing needs and options
- Submit loan application with financial documentation
- Lender reviews application and issues pre-approval letter
- Shop for homes within pre-approval amount
- Make offer and enter into purchase agreement on home
- Lender processes loan request and underwrites mortgage
- Provide updated documentation and complete tasks requested by lender
- Lender issues final loan approval
- Close on home purchase and sign loan documents
The key difference is in the underwriting process. Lenders will scrutinize a non-conforming loan application more thoroughly to ensure the higher lending risks meet their approval guidelines.
Borrowers may also pay higher interest rates, mortgage insurance premiums, and fees to offset the increased risk of issuing a non-conforming loan.
Types of Non-Conforming Loans
There are several types of mortgages that are classified as non-conforming:
Jumbo Loans
The most common type of non-conforming loan is a jumbo loan. This refers to any loan amount that exceeds the conforming loan limit set by the FHFA. The conforming limit in 2023 is $726,200 in most U.S. counties, but goes up to $1,089,300 in certain high-cost areas.
Jumbo loans are ideal for luxury real estate or high-cost regions where home values routinely surpass the conforming limits. Borrowers need excellent credit and sufficient assets and income to qualify.
Low/No Down Payment Loans
Fannie Mae and Freddie Mac generally require at least 20% down to avoid private mortgage insurance (PMI). Loans with less than 20% down are non-conforming. These include:
- FHA loans with 3.5% down
- VA loans with 0% down
- USDA loans with 0% down
- 97% LTV conventional loans
Lower down payment programs expand homeownership opportunities for buyers who lack funds for a large down payment. Government programs like FHA, VA, and USDA provide added backing.
Alternative Documentation Loans
Conforming loans typically require full income and asset documentation. Non-conforming alternative doc loans may allow:
- 12 or 24 months of bank statements instead of tax returns
- 1099s, W-2s, or paystubs to verify income
- Asset statements rather than source documents
Alternative doc loans help borrowers who are self-employed, have complex income sources, or cannot supply traditional documentation.
Loans for Non-Warrantable Condos
Certain types of condos are ineligible for conforming loans, including:
- New constructions not meeting presale requirements
- Condos where a single entity owns more than 10% of units
- Condos with commercial space exceeding 25%
- Condos in litigation with homeowners association
- Condos without sufficient insurance coverage
Non-warrantable condo loans provide financing options for buyers purchasing ineligible condo projects.
Foreign National Loans
Conforming loans require U.S. citizenship or permanent residency. Foreign nationals here on non-permanent visas need a non-conforming mortgage. These loans typically have higher down payments, interest rates, and restrictions.
Non-Prime Credit Loans
The minimum FICO scores for conforming loans are generally 620 to 640. Non-conforming loans are available for borrowers with scores below those thresholds. Subprime and alt-A loans offer financing for applicants with past credit issues at a higher cost.
Interest-Only Loans
Conforming mortgages feature amortized payments covering interest and principal. Non-conforming interest-only loans allow lower payments on interest initially, with higher payments later covering principal.
Benefits of Non-Conforming Loans
Though more expensive, non-conforming home loans provide key advantages:
- Higher loan amounts – Jumbo loans allow buyers to purchase more expensive homes.
- Lower down payments – Just 3.5% or 0% down opens homeownership.
- Flexible documentation – Alternative doc loans help unconventional borrowers.
- Specialized products – Solutions for niche home types and situations.
- Access to credit – Financing for lower credit scores.
- Customized payments – Interest-only loans offer lower initial payments.
Ultimately, non-conforming mortgages give borrowers more ways to buy and finance real estate. They provide options when a conventional conforming loan isn’t feasible.
Drawbacks of Non-Conforming Loans
The disadvantages of non-conforming home loans include:
- Higher interest rates – Usually 0.25% to 0.5% higher for jumbos, and 1% to 5% higher for non-prime.
- More fees – Can include origination fees, application fees, and points.
- Prepayment penalties – Some programs charge fees for paying off loan early.
- Tighter limits – Lower maximum loan amounts than conforming loans.
- Risk of ARM adjustments – Interest rates and payments could rise over time.
Additionally, non-conforming loans may be tougher to qualify for, shop for, and close. Lenders will scrutinize applications more closely. Limited competition among lenders can reduce borrower bargaining power on rates/fees.
Who Should Consider a Non-Conforming Loan?
Non-conforming home loans serve a wide range of buyer situations:
- Jumbo loans – High earners buying luxury real estate or in high-cost regions.
- Low down payment loans – First-time buyers lacking funds for 20% down.
- Alternative documentation – Self-employed, contractors, or unconventional income sources.
- Lower credit buyers – Past bankruptcy or foreclosure. Current scores below conforming thresholds.
- Interest-only – Investors seeking lower initial payments and flexible terms.
- Foreign nationals – Non-residents and visa holders.
- Non-warrantable condos – Buyers interested in ineligible condo properties.
Carefully compare conforming and non-conforming loan options to choose the most beneficial mortgage for your unique needs and financial circumstances.
Finding and Applying for a Non-Conforming Loan
Shopping for a non-conforming loan is best done through an experienced mortgage broker. Brokers have relationships with multiple wholesale lenders offering non-conforming programs. This gives expanded access to specialized products.
Mortgage brokers can also advise you on the optimal loan types and lenders for your specific situation. They guide you through submitting a strong application to improve your chances of approval.
You can also work directly with retail lenders offering non-conforming loans. These are often small local lenders, credit unions, or specialized non-conforming lenders. Ask about their unique non-conforming products to see if they meet your needs.
Be prepared to provide extensive documentation to prove your income, assets, credit, and overall ability to handle the higher costs and obligations of a non-conforming loan. With proper preparation and guidance, a non-conforming mortgage may open the doors for you to buy or refinance your dream home.
The Bottom Line
Non-conforming home loans fill an important niche, providing mortgage financing to borrowers who don’t qualify for conventional conforming loans. While
What Is a Non-Conforming Mortgage?
A non-conforming mortgage is a mortgage that does not meet the guidelines of government-sponsored enterprises (GSE) such as Fannie Mae and Freddie Mac and, therefore, cannot be sold to them. GSE guidelines include a maximum loan amount, suitable properties, down payment requirements, and credit requirements, among other factors.
A non-conforming mortgage may be contrasted with a conforming mortgage.
- A non-conforming mortgage is a home loan that does not adhere to government-sponsored enterprises (GSE) guidelines and, therefore, cannot be resold to agencies such as Fannie Mae or Freddie Mac.
- These loans often carry higher interest rates than conforming mortgages.
- Mortgages that exceed the conforming loan limit are classified as non-conforming and are called jumbo mortgages.
- Other than the loan size, mortgages may become non-conforming based on a borrower’s loan-to-value ratio (down payment size), debt-to-income ratio, credit score and history, and documentation requirements.
Understanding Non-Conforming Mortgages
Non-conforming mortgages are not bad loans because they are risky or overly complex. Financial institutions dislike them because they do not conform to GSE guidelines and, as a result, are harder to sell. For this reason, banks will usually command a higher interest rate on a non-conforming loan.
Although private banks initially write most mortgages, they often end up in Fannie Maes and Freddie Macs portfolios. These two GSEs buy loans from banks and package them into mortgage-backed securities (MBS), which sell on the secondary market. An MBS is an asset-backed security (ABS) secured by a collection of mortgages originating from a regulated and authorized financial institution. While there are private financial companies who will buy, package, and resell an MBS, Fannie and Freddie are the two largest purchasers.
Banks use the money from the sales of mortgages to invest in offering new loans at the current interest rate. But Fannie Mae and Freddie Mac cant buy just any mortgage product. The two GSEs have federal rules limits to buying loans deemed relatively risk-free. These loans are conforming mortgages, and banks like them precisely because they will readily sell.
By contrast, mortgages Fannie Mae and Freddie Mac cannot buy are inherently riskier for banks to write. These difficult-to-sell loans must either stay in the banks portfolio or be sold to entities specializing in the secondary market for non-conforming loans.
Non-Conforming Loan Tips
FAQ
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