What Is a Non-Conforming Loan? Is It Right for You?

Written by Elijah BishopUpdated: 28th Dec 2021
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When getting a mortgage to buy or refinance your house, you’re bound to come across several mortgage terminologies.

And your ability to fully understand what they mean and how they can affect your mortgage process is your first step to choosing the best mortgage. One of such terms is the non-conforming mortgage.

On a lighter scale, a non-conforming mortgage is a home loan that doesn’t meet the requirements set by Fannie Mae and Freddie Mac, the two government-sponsored enterprises (GSE).

In this article, we’ll discuss what a non-conforming mortgage is all about, its pros and cons, and the various requirements.

Let’s dive right in to find out more about non-conforming mortgages.

What Is a Non-Conforming Loan?

A non-conforming loan is a type of mortgage that does not meet the guidelines set by Fannie Mae and Freddie Mac.

For example, these mortgages may have a higher interest rate than conforming loans or require more income documentation.

Also, private mortgage lenders usually make non-conforming loans that create guidelines that borrowers must meet to get approved.

Non-conforming loans typically include jumbo loans (loans beyond the GSE loan limits) and government home loanslike FHA, VA, and USDA loans. A loan is considered non-conformed if it allows for the following:

  • Poor credit score requirement
  • Lower minimum down payment requirement
  • Higher debt-to-income (DTI) ratio
  • High loan limits, especially for jumbo loans
  • Use of the loan for unconventional purposes

Applying for a non-conforming loan can be an excellent choice if you fail to qualify for a conforming loan.

Also, applying for jumbo loanscan help you evade the strict conforming loan limits.

How Do Non-Conforming Loans Work?

Since non-conforming loans do not adhere to Fannie Mae and Freddie Mac guidelines, its rules of operation are quite different.

Generally, in a non-conforming loan:

  • The loan amounts are higher
  • The required documentation is more extensive
  • You may need to provide a larger down payment
  • Interest rate, closing costs, and origination fee may be higher
  • Credit score may be higher

In the following section, we will go into more detail about the workings of a non-conforming mortgage.

Loan Amount

Non-conforming mortgage amount varies yearly and by location. In 2021, the non-conforming mortgage amount starts at $548,250.

And in areas with high home value, the non-conforming mortgage amount begins at $822,375.

Documentation

If you’re applying for a non-conforming loan, you should be prepared to present your lender with multiple documents.

You’ll need to submit proof of your income tax returns, pay stubs, and bank statements. Most online mortgage lenderswill require documents that unravel your income, investments, and credit to determine your creditworthiness.

Down payment

While it is common for non-conforming loan lenders to accept a down payment of less than 20%, you may have to carry private mortgage insurance (PMI).

Credit Score

If you’re applying for a non-conforming loan, you’ll need a credit score of at least 680 to obtain the loan.

Since private lenders make the rules surrounding non-conforming loans, they often set their credit score requirements.

More importantly, your credit score will highly influence the rate you pay for the loan.

Debt-to Income ratio

Non-conforming loan lenders often require borrowers to have a DTI ratio of 40% or less. However, lenders may accept a higher DTI in exchange for a bigger cash reserve or down payment.

Cash Reserves

Private lenders often request that you have a sizeable cash reserve on hand when applying for a non-conforming loan.

Typically, the specific amount of cash reserve varies by lender but is often a years’ worth of mortgage payment.

Interest Rate

Interest rates on non-conforming loans are usually higher than conforming loans. Since private lenders set the guidelines for non-conforming loans, your interest rate depends on the lender and market situation.

Closing Costs and Fees

Closing costs on a non-conforming loan are pretty higher when compared to conforming loans because loan fees are calculated as a percentage of your mortgage balance.

You should also be prepared to pay for extra closing costs to cover the costs of multiple property appraisals and lenders’ fees.

>> More: Differences Between Conforming and Non-Conforming Loans 

Types of Non-conforming Mortgages

There are several types of non-conforming mortgages. They include:

#1. Government-Backed Loans

Government-backed loans are those types of loans insured by the federal government. If a borrower default on the payment of the loan, the government foots the bill and protect the lender from any loss.

And since government-backed loans pose less risk, it is common for lenders to offer loans to borrowers with lower down payments and credit scores.

However, you must meet specific criteria to qualify for one. Currently, there are three types of government-backed loans: VA loans, FHA loans, and USDA loans. Each of these loans comes with its target home buyer, requirements, and fees.

  • VA loan: VA loans are insured by the Department of Veteran Affairs and targeted at members of the armed forces, veteran, and their spouses. Also, unmarried widows of service members who lost their lives in the line of duty or through a service-sustained disability. VA loan allows qualified individuals to purchase a mortgage with zero down payment and an average FICO score of 580 or higher. See the best VA Mortgage lenders.
  • USDA loan: USDA loans are insured by the United States Department of Agriculture and targeted at buyers looking to purchase a home in a rural area. According to the USDA, before a home can qualify for a loan, it must be located in an area considered sufficiently rural. In addition, you must not earn more than 115% of your county median income, and neither should the intending home be a working farm. More importantly, USDA loans allow you to buy a home with zero down payment and a credit score as low as 640.
  • FHA loans: Insured by the Federal Housing Administration, an FHA loan allows you to buy a home with as little as 3.5% down. However, you must have an average credit score of at least 580 and a low DTI ratio.

#2. Jumbo Loan

A loan is considered a jumbo loan if its loan amount is beyond the loan limit set by Fannie Mae and Freddie Mac.

One of the significant upsides to jumbo loans is that they don’t have high-interest rates compared to conformingconventional loans.

However, jumbo loans have some of the strictest mortgage requirements. Generally, most lenders will require that you have a credit score in the 700s and a lower DTI ratio.

Non-Conforming Loan Limits and Requirements

If you’re applying for a non-conforming loan, the requirements and limits vary across the type of mortgage you are applying for and the lender offering it.

For example, while VA loans and jumbo loans are both non-conforming loans, their requirements differ.

But in general, here is a standard non-conforming loan requirement.

  • Minimum credit score: 580
  • Maximum loan limits: Varies by program and lender
  • Maximum debt-to-income ratio: Varies by program and lender
  • Minimum down payment required: Varies by program and lender, but you may be more likely to be approved with a down payment of at least 20%.

What Are the Advantages of Non-Conforming Loans?

Advantages of taking out a non-conforming loan include:

  • Lower down payment requirement: Non-conforming government-backed loans offer one of the lowest down payments compared to conventional loans. If you qualify for USDA and VA loans, you may be able to buy a home with zero down.
  • Larger Loan limit: If you are looking to purchase an expensive house, you may have no choice but to opt for a non-conforming jumbo that allows for higher loan limits than conforming loans.
  • Access to different property types: Depending on the type of non-conforming loan you take, you may be able to finance the purchase of a kind of property that you can’t get with a conforming loan.
  • Lower credit requirement: It is common for lenders to offer non-conforming loans to individuals with negative marks on their credit report or who have filed for bankruptcy in the past. Keep in mind that this comes at an expensive cost in terms of interest rate.

What Are the Disadvantages of Non-Conforming Loans?

Disadvantages of taking out a non-conforming loan include:

  • Less Available: Only a few lenders offer non-conforming jumbo loans due to the risk involved. However, most lenders provide other forms of non-conforming loans like FHA and USDA loans.
  • Higher interest rates: Lack of government backing means more risk on the part of the lender. Therefore, lenders tend to offer higher interest rates to quantify the risk of providing non-conforming jumbo loans.
  • Less Standardization across lenders: Since there is less government interference with non-conforming loans, it is common for lenders to offer personalized requirements. You should work with a professional when applying for a non-conforming loan.

Frequently Asked Questions

Is a Jumbo Loan a Non-Conforming Loan?

Yes, a jumbo loan is a non-conforming loan. A jumbo loan is the primary type of non-conforming loan since it doesn’t conform to Fannie Mae, Freddie Mac, or any of the government agency guidelines.

Can You Refinance Non-Conforming Loans?

Just like with any other mortgage loan, you can refinance a non-conforming loan. Maybe you need to switch to a lower interest rate, get some cash, or even move to a conforming loan; a non-conforming loan offers you the opportunity to achieve all these.

When Does a Non-conforming Loan Make Sense?

There are several situations where getting a non-conforming loan may be your best option. A non-conforming loan works best if you fall under the following categories:

  • If you want to take advantage of zero down payments and lower credit requirements.
  • If you want to purchase a more expensive house beyond the loan limits of conforming loan
  • If you have filed for bankruptcy in the past or have negative marks on your credit report
  • If you don’t qualify for conforming loans or conforming conventional loans.

Bottom Line: What is a Non-conforming Loan?

While aconforming loanmeets the purchase guidelines and loan amount limits of Fannie Mae and Freddie Mac, a non-conforming loan does not.

A non-conforming loan does not conform to the lending requirement of Fannie Mae or Freddie Mac.

Government-backed loans and jumbo loans are some of the popular non-conforming loans available to buyers.

More importantly, while non-conforming loans offer some of the lowest credit score and down payment requirements, these loans boast of high-interest rates.

In addition, you should speak to a mortgage professional before taking out a non-conforming loan.

Elijah Bishop
Elijah Bishop

Elijah A. Bishop is a Senior Personal Finance Writer who has been writing about real estate and mortgages for years. He has a Bachelors of Arts Degree in Creative writing from Georgia State University and has also attended the Climer School of Real Estate. He also holds a realtor license and has been in and out of the US mortgage industry as a loan officer. Bringing over 15 years of experience, Elijah produces content that analyzes ethnicities, race, and financial well-being. His areas of expertise are mortgages, real estate, and personal loans.