What is a Non-Conforming Loan?

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There are several types of mortgage loans that can help you purchase property. The job of your lender is to make the determination about which one is best for you based on both your individual situation and bank and government guidelines. One way that mortgage loans are differentiated from each other is by classifying each as either a conforming loan or a non-conforming loan. Conventional mortgage loans that banks and other financial institutions offer to their customers may be either conforming or non-conforming. 

What Are Non-Conforming Loans?

Non-conforming loans, also called jumbo loans, are mortgage loans that are made on properties that are not eligible for insurance by the government programs, Fannie Mae and Freddie Mac. Banks and other financial institutions make loans insured by these agencies who then package them and sell them to investors. These are called conforming loans. Non-conforming loans are usually made by private lenders that stipulate their own requirements for approval. These loans serve as part of their investment portfolios.

There are several ways that non-conforming loans differ from conforming loans:

How Non-conforming Loans Work

In a non-conforming loan:

  • The loan amounts are higher.
  • The documentation is more extensive.
  • The down payment may be larger.
  • The required credit score may be higher.
  • The debt-to-income ratio is firm.
  • Significant cash reserves may have to be on hand.
  • Interest rates may be higher.
  • Closing costs and fees may be higher.

Loan amounts: Loan amounts on a non-conforming mortgage loan can be above $484,350 in 2019. In the northeast and on the west coast, that loan amount can go all the way up to $726,525. There are isolated areas in the U.S. where it can go even higher.

Documentation: Be prepared to provide the lender with extensive documentation, for several years, of your income tax returns, pay stubs, bank statements, appraisals of assets, and other material in order to qualify for a non-conforming mortgage loan.

Down Payment: Some lenders require a down payment of only around 10 percent, but they usually require private mortgage insurance with a down payment at that level. Many lenders require a down payment of around 20 percent or even a little more, depending on the loan. 

Credit Score: Required credit scores will range between, at a minimum, 700-750. Since private lenders make non-conforming loans, they set their own credit scores and can adjust them up or down.

Debt-to-Income Ratio: The maximum debt-to-income ratio that most lenders enforce is 45 percent, but they may make exceptions depending on the circumstances.

Cash Reserves: Most lenders of non-conforming loans will ask that there are significant cash reserves on hand since they would take quite a loss in case of foreclosure due to the size of the loan. The amount of cash reserves is set by each lender but is often one year’s worth of mortgage payments.

Interest Rate: The interest rate on a non-conforming loan is almost always slightly higher than on a loan of less value. Lenders try to be competitive and keep interest rates as low as possible.

Closing Costs and Fees: Closing costs and fees are higher on a non-conforming mortgage because fees are calculated as a percentage of the mortgage balance There are also additional closing costs for this type of mortgage such as multiple appraisals.

These are general guidelines for non-conforming loans. Because the lenders are private, any of the guidelines, except loan limit, are up to their discretion. There are other benefits of a non-conforming loan over a conforming loan:

  • Loan limits are higher.
  • Mortgages are available on commercial property.
  • Mortgages may be available even if you have had a bankruptcy.

Conforming Loans

Conforming loans are made by banks and other financial institutions and backed by Fannie Mae and Freddie Mac. They have characteristics that are different from the non-conforming loans:

  • Loans must be under the $484,350 limit for 2019.
  • The down payment may be as low as 3 percent of the price of the home.
  • The down payment and closing costs may be gifted.
  • The borrower’s credit score can be no lower than 630-650.
  • The debt-to-income ratio can be no higher than 36 percent. It can be 45 percent depending on the borrower’s credit score and reserve requirements.

Conforming loans have some benefits over non-conforming loans:

  • Flexibility: Since conforming loans have to conform to the same standards across financial institutions, the borrower often has a choice of lenders.
  • Lower interest rates: The interest rates of conforming loans are usually lower than the interest rates of non-conforming loans.

If you are preparing to apply for a conforming mortgage loan, keep in mind that you want to keep your credit score up to the standard and have a spotless credit history. Go over your credit report and be sure there are no errors that could drag down your credit score.

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