Non-conforming loans explained
Quick insights
- Non-conforming loans are ones that don’t follow the standards set by Fannie Mae® and Freddie Mac®.
- With examples including jumbo loans and interest-only mortgages, a non-conforming loan can be larger in size or have less traditional terms than conforming loans.
- A non-conforming loan is often for unique borrowing situations, such as for people who have larger borrowing needs, are self-employed or have lower credit scores.
Figuring out the lingo around home loans can feel overwhelming, especially for first-time homebuyers. With so many types, terms and conditions to consider, it’s easy to get lost in a sea of jargon.
One type of loan you might encounter is a non-conforming loan. Below, we’ll break down what it is, how it works and whether it might be the right fit for you.
What is considered a non-conforming loan?
What is a non-conforming loan, exactly? To put it simply, a non-conforming loan is a mortgage that doesn’t meet the criteria set by Fannie Mae and Freddie Mac, the two government-sponsored enterprises (GSEs) that buy and sell mortgages to maintain stability in the housing market.
In a nutshell, Fannie Mae and Freddie Mac make mortgages widely available. They do this by purchasing loans from lenders and bundling them into securities for investors.
If a loan doesn’t fit Federal Housing Finance Agency (FHFA) guidelines, it’s labeled as non-conforming. Here are the main reasons why a loan might fall into the non-conforming category:
- Loan amount: If the loan exceeds the conforming loan limit (CLL)—currently $806,500 in most parts of the U.S. or $1,209,750 in high-cost areas—it’s non-conforming. These larger loans are often called jumbo loans.
- Credit score and DTI: If a borrower’s credit score or debt-to-income (DTI) ratio doesn’t fit within Fannie Mae or Freddie Mac guidelines, the loan may not qualify as conforming.
- Non-traditional loan structures: Mortgages with unusual terms, like interest-only payments or extended repayment periods beyond the standard 15 or 30 years, can also fall into the non-conforming category.
How does a non-conforming loan work?
Non-conforming loans function similarly to their conforming counterparts, but there are a few differences in how they’re handled by lenders. First, non-conforming loans typically aren’t purchased by Fannie Mae or Freddie Mac to be packaged and resold to investors. Instead, lenders usually keep these loans on their books. Because these loans carry higher risks for lenders, they often require more thorough underwriting and might feature stricter approval criteria.
That said, non-conforming loans offer borrowers flexibility that conforming ones do not, such as customized terms or greater borrowing amounts for unique situations.
Although they require more effort to process, many lenders specialize in non-conforming loans, making them accessible for a range of needs.
Is a non-conforming loan the same thing as a non-conventional loan?
It’s understandable to confuse non-conforming and non-conventional loans, but the two aren’t the same. All conforming loans are conventional loans. However, not all conventional loans are conforming loans.
Conforming loans versus non-conforming loans are defined based on whether the loan meets Fannie Mae and Freddie Mac standards. Conventional versus non-conventional loans, however, are categorized by the type of lender and funding source. Conventional loans are offered by private lenders like banks, credit unions and mortgage companies, while non-conventional loans are backed by government programs.
FHA, U.S. Department of Agriculture (USDA) and U.S. Department of Veterans Affairs (VA) loans are considered both non-conventional and non-conforming. However, a jumbo loan would be considered non-conforming but conventional since it’s issued by a private lender and not tied to a government program.
What is an example of a non-conforming loan?
Non-conforming loans come in many forms, each suited to specific financial situations. Here are a few common examples:
Jumbo loans
The jumbo loan is the most obvious example of a non-conforming conventional loan. These loans are a good choice for anyone looking to buy in high-cost real estate markets or aiming for a luxury home. These allow you to borrow amounts that are beyond the conforming loan limits set by Fannie Mae and Freddie Mac.
However, non-conforming loans often come with tighter credit scores and higher down payment requirements since they pose more risk for lenders.
Government-backed loans
These loans often appeal to first-time buyers due to lower down payment requirements. Government-backed loans include:
- FHA Loans: Designed for low-to-moderate income buyers, FHA loans offer relaxed credit score requirements and low down payments.
- VA Loans: Reserved for eligible military members and their families, VA loans often require no down payment and lower interest rates.
- USDA Loans: These loans support rural and suburban buyers, offering low interest rates and no down payment for qualifying properties. (Chase does not offer USDA loans at this time.)
Hard-money loans
Hard-money loans are short-term loans that are typically provided by private lenders. The loan could be desirable when quick funding is needed, such as real estate investments. These loans often have higher interest rates but offer borrowers a bit more wiggle room in their timelines.
Owner or seller financing
With this type of non-conforming loan, the seller acts as the lender. This unique situation allows buyers to make payments directly to them instead of to a bank. You may hear owner financing also referred to as a “holding mortgage,” an arrangement in which the seller retains the mortgage to act as the lender.
Purchase-money mortgage
This arrangement involves the seller providing the financing directly to the buyer. It’s often used when the buyer can’t qualify for traditional loans, whether that’s due to an insufficient down payment or credit issues. A purchase-money mortgage generally comes with a higher interest rate and shorter repayment term than a conforming loan.
Interest-only mortgage
For an interest-only loan, borrowers only pay the interest for a set period before the loan switches to regular amortization, including both interest and principal. This results in lower monthly payments at first but transitions to higher payments when principal repayments begin.
Bridge loans
A bridge loan helps buyers purchase a new home while waiting for their current home to sell. It’s a short-term option designed to offer temporary financial relief and flexibility in an unpredictable housing market.
Advantages of non-conforming home loans
Non-conforming loans can open doors that might otherwise seem firmly closed. Here's why they appeal to many homebuyers:
Flexible down payment requirements
Some non-conforming loans allow for lower down payments, making homeownership more accessible for those who haven’t saved the traditional 20%.
Larger loan limits and less rigid credit standards
Got your eye on a more expensive property? Non-conforming loans, especially jumbo loans, offer higher limits than conforming ones. Similarly, borrowers with less-than-ideal credit may still qualify for FHA-backed mortgages.
Easier for the self-employed
If you’re self-employed or have an irregular income, certain non-conforming loans (like bank statement loans) take these circumstances into account.
Disadvantages of non-conforming home loans
While they offer flexibility, non-conforming loans come with downsides that buyers should consider.
Limited lender options
Not every lender offers non-conforming loans, which means your choices might be more restrictive.
Higher costs
Since non-conforming loans can carry more risk for lenders, they often come with higher interest rates and fees.
Additional closing costs
You may encounter more out-of-pocket expenses at closing. These might include higher origination fees or application fees.
Greater risk
If you borrow more than you can handle, it could lead to financial strain. The guidelines for conforming loans exist to protect borrowers from taking on unsustainable debt.
May restrict your property choice
While non-conforming loans can, in some cases, be used for any type of property, that isn’t always the case, depending on the lender.
Many non-conforming loans can generally only be used to purchase a primary residence. Second homes, investment properties and vacation homes are often excluded, though that’s not always the case. Check with your lender if you’re unsure if your property type will qualify.
In summary
Ultimately, the choice between a conforming and non-conforming loan depends on your unique situation. Do you need a larger loan amount or greater flexibility in terms? If so, a non-conforming loan could be a smart solution.
When in doubt, consider consulting a mortgage professional who can guide you based on your personal financial goals and the housing market where you’re choosing to buy.
Weigh the risks carefully, and be sure to shop around for options. There’s no single best loan, but there may be the right type for you.
