What Are Non-Conforming Loans?

These days, the convenience and ease of borrowing money allow us to navigate complicated financial situations in every aspect of life. It’s how we finance cars, education, and much more. Even credit cards help us facilitate both critical and trivial purchases through the premises of a loan. 

Housing is no exception. If you’re browsing home listings with hopes of buying the house of your dreams, it’s important to understand different kinds of home loans. In this article, we’ll discuss non-conforming loans and explore various types to help you determine if one of them may be the right route for you.

What is a non-conforming loan?

To establish what a non-conforming loan is, we must first discuss the definition of a conforming loan. Simply put, a conforming loan meets the standards for Fannie Mae and Freddie Mac, government-sponsored enterprises that buy mortgages from other lenders. The Federal Housing Finance Agency (FHFA) sets the rules for the mortgages these entities can purchase. 

A non-conforming loan, as expected, does not conform to these guidelines. Instead, they are usually government-backed, such as USDA, VA, or FHA loans. Jumbo loans are another example of a non-conforming loan because they exceed the Fannie Mae and Freddie Mac limits. For 2022, the FHFA set the maximum at $647,200.

With that out of the way, let's look at the various kinds of non-conforming loans.

Types of non-conforming loans

There are a few different categories of non-conforming loans among different lenders. Here’s what you should know about each of them.

Government loans

Under this umbrella, you’ll find loans involving the Department of Veterans Affairs (VA), Department of Agriculture (USDA), and Federal Housing Administration (FHA). All of these are backed by the government. 

• VA Loans: Reserved for eligible active-duty service members, veterans, reservists, and surviving spouses of those who passed away due to service-related reasons. This loan does not require a down payment.
• USDA Loans: Intended for those in rural areas, there is no down payment required for this type of loan if your household income is below 115% of the area median.
• FHA Loans: Ideal for those with poor credit scores, this loan offers easy credit qualifying in addition to low down payments and closing costs.

Jumbo loans

A very common type of non-conforming loan that comes with higher loan limits is a jumbo loan. These are especially helpful for those who need loans to invest in real estate as borrowing limits can be in the millions. 

Qualifications vary by lender, but you will need a down payment, and your debt-to-income ratio must be lower than required for a traditional loan. Your credit score must be at least 680 in most cases.

Other loans

In addition to government-backed loans and jumbo loans, other non-conforming loans include:

• Interest-only mortgages
• Holding mortgages
• Hard money loans
• Purchase-money mortgages

Non-conforming loan requirements

Requirements for non-conforming loans can vary depending on the lender and the type of loan. The following requirements are simply a general overview:

• A credit score of at least 580
• Maximum loan limits depending on the lender and program
• A maximum debt-to-income ratio to be determined by the lender
• Depending on the type of loan, you may owe a minimum down payment of at least 20%

The pros and cons of non-conforming loans

Choosing between a conforming or non-conforming loan comes down to a handful of pros and cons. As you take your personal situation into consideration, use this list to help guide your decision.

Pros

• Higher loan amounts are available if necessary.
• You may not have to provide a down payment in the case of a VA or USDA loan.
• Lower credit scores are usually acceptable, as well as negative marks pertaining to bankruptcy.

Cons

• Fewer lenders provide these types of loans, which may limit your ability to shop around for the best mortgage rate.
• Higher interest rates are common due to the flexibility of these loans (higher amounts, no down payment, etc.).
• There is more variation across lenders because these loans don’t meet the standards set forth by Fannie Mae and Freddie Mac.

Is a non-conforming loan right for you?

Before you decide to make an offer on a home, you’ll need to sort through loan options and get a pre-approval letter. That’s why it’s important to decide whether a conforming or non-conforming loan is the right choice for you. 

While a conforming loan may be cheaper for a reasonable home, some buyers enjoy the perks of a non-conforming loan. For example, service members often take advantage of VA loans to forgo making a down payment. Further, there are always other ways to save when you’re purchasing a home. Be sure to explore your options by asking brokerages or real estate agents about different strategies for getting the best deal on a purchase.

Consider your personal financial situation, credit score, and the resources available to you before you decide which kind of loan to go with.