What is a Non-Conventional Loan? A Comprehensive Guide

Getting a mortgage can be an intimidating process, especially when you start hearing terms like “conventional loan” and “non-conventional loan”. While a conventional loan is the most common type of mortgage a non-conventional loan can provide more flexibility and options for certain borrowers. In this comprehensive guide we’ll break down exactly what a non-conventional loan is, the different types available, and help you determine if this route is right for your home buying needs.

A non-conventional loan is a mortgage that does not conform to the standards and loan limits set by Fannie Mae and Freddie Mac. These government-sponsored enterprises purchase loans from lenders and repackage them into mortgage-backed securities that are then sold to investors on the secondary market.

To provide stability in the housing market, Fannie and Freddie establish baseline requirements like maximum loan amounts, minimum credit scores, and acceptable debt-to-income ratios. Loans that fall outside of these parameters are considered “non-conforming” and are not purchased by Fannie or Freddie.

Instead, non-conventional loans are financed and held directly by banks, credit unions, and other private lenders. As a result, underwriting guidelines tend to be more flexible than conventional conforming loans. Non-conventional mortgages open up homeownership opportunities for borrowers who may not qualify through traditional means.

Common Types of Non-Conventional Loans

There are two main categories of non-conventional mortgage loans:

Government-Backed Loans

Government-backed loans are insured or guaranteed by government agencies like the FHA, VA, or USDA. They help provide affordable financing options for eligible borrowers:

• FHA loans – Offered by private lenders and insured by the Federal Housing Administration. Require lower minimum credit scores and down payments as low as 3.5%. Popular for first-time homebuyers.

• VA loans – Provided by private lenders and guaranteed by the Department of Veterans Affairs. Offer 100% financing with no down payment requirement for qualifying veterans and service members.

• USDA loans – Backed by the U.S. Department of Agriculture and aimed at low-to-moderate income buyers in rural areas. Feature 100% financing and flexible credit guidelines.

Jumbo Loans

Jumbo loans exceed the conforming loan limits set by the FHFA. In 2023, the baseline conforming limit is $726,200 for single-family homes in most US counties. Jumbo loans provide financing above that threshold. They are offered by banks and lenders to qualify buyers looking to purchase more expensive properties.

Benefits of Non-Conventional Loans

There are many advantages to non-conventional mortgage financing:

• Lower down payments – Government programs like the FHA, VA, and USDA allow down payments as low as 0%. This helps borrowers get into a home sooner.

• Relaxed credit requirements – Programs like FHA have minimum credit score requirements as low as 580. VA and USDA loans also offer more flexibility for lower credit borrowers.

• Higher loan amounts – Jumbo loans allow buyers to finance luxury homes that cost more than conforming loan limits.

• Options for self-employed borrowers – Non-conventional loans can offer more ways to verify income for borrowers who are self-employed or have non-traditional income sources.

• No mortgage insurance – Government loans like VA and USDA do not require private mortgage insurance payments, which saves borrowers money each month.

What Do You Need to Qualify?

While non-conventional loans offer more flexibility, there are still requirements borrowers must meet:

• Credit score – Each program sets minimum scores ranging from 500 FICO for FHA to 620 for jumbo loans. Specific guidelines vary by lender.

• Debt-to-income ratio – Most non-conforming loans require a maximum DTI of 50%. VA loans allow ratios up to 60% with compensating factors.

• Down payment and reserves – Low down payment programs require at least 3.5% down for FHA loans. Jumbo loans often require 10-20% down. Lenders also look for sufficient cash reserves post-closing.

• Occupancy and property type – Non-conforming loans have varying rules regarding primary residence vs investment property, condos vs single-family homes, acreage limits, etc.

How Do I Choose Between Loan Types?

Determining if a non-conventional loan fits your situation depends on a few key factors:

Loan Amount Needed

If your purchase price exceeds conforming limits, a jumbo loan would be your only option without having to put down a large down payment.

Down Payment Size

Programs like FHA or VA allow much lower down payments for buyers without a lot of cash saved up. This can help you buy sooner.

Credit Profile

Borrowers with fair or poor credit often benefit from the flexible credit guidelines of government non-conforming loans. Minimum scores are lower than conventional loans.

Occupancy Type

Certain loans only apply for primary residences. Jumbo loans usually require owner-occupancy as well. VA loans work for 2-4 unit investment properties.

Property Location

USDA and VA loans have limits on the location of the home you can purchase with their programs. Research guidelines carefully.

Loan Terms

Government loans allow longer 30-40 year loan terms which means lower monthly payments. Jumbo loans usually top out at 30 years.

Work with a Trusted Lender

Non-conventional loans offer many perks, but make sure you have an experienced loan officer guide you through the mortgage process. A reputable lender can assess your situation, explain all the options clearly, and help determine if a non-conforming loan is the right solution for your home buying needs and financial goals. They can also walk you through the application process and loan approval specifics.

The world of non-conventional mortgages provides more possibilities when buying a home. With the right education and resources, these loans can help make your dream of homeownership a reality.