What Is a Non-Conforming Loan?

Non-Conforming Loans Explained

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Non-conforming loans are mortgages that fall outside the jurisdiction of standard government loan insurers Fannie Mae and Freddie Mac.

What Are Non-Conforming Loans?

Non-conforming loans are high value mortgage loans and those made to borrowers who would not typically qualify for a loan backed by Fannie Mae or Freddie Mac.

Non-conforming loans are usually made by private lenders that create their own rules around the standards borrowers must meet in order to be approved.

These loans serve as part of the private lenders' investment portfolios. Unlike conventional mortgage loans, they are not bundled and resold.

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 credit score threshold may be higher
  • The debt-to-income ratio is firm
  • Major cash reserves may have to be on hand
  • Interest rates may be higher
  • Closing costs and fees may be higher

Loan Amounts

Non-conforming mortgage amounts vary by year and locale. In 2021 they are those for more than $548,250, which is up from $510,400 in 2020. In places where the cost of homes is much higher, non-conforming mortgage amounts start above $822,375 in 2021, which is up from $765,600 in 2020.

Documentation

If you are seeking a loan outside of the standard channels, be prepared to provide the lender with a lot of information. You'll need to show many years of your income tax returns, pay stubs, and bank statements If you have any other assets or items of value, you may be asked to have them appraised. Lenders will seek out any bit of material that may be relevant to your wealth, credit, or income, in order to decide whether you are a safe enough bet to offer a loan.

Down Payment

Some lenders will accept a down payment of only 10%, but this is nor common. More often, they will require private mortgage insurance with a down payment at that level. Many lenders require a down payment of around 20% or even a little more, but the exact amount depends on the details of the loan.

Credit Score

You will need a credit score of at least 680 to obtain this loan. Since private lenders make non-conforming loans, they set their own credit score limits and can adjust them up or down. Your credit score will also affect the interest rate you pay, so a higher credit score could save you money over the life of the loan.

If you are planning to apply for any type of mortgage loan, you want to keep your credit score up to the standard and have a spotless credit history. Spend the time to go over your credit report and be sure there are no errors that could drag down your credit score.

Debt-to-Income Ratio

Lenders look for a debt-to-income ratio of 40% or less, but they might settle for less if you have access to a large amount of liquid assets.

Cash Reserves

Most lenders of non-conforming jumbo loans will ask that you have a fair amount of cash reserves on hand. This is because 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 it would be on a loan of less value. Lenders do compete to keep interest rates as low as they can, while still making money.

Closing Costs and Fees

Closing costs and fees are higher on a non-conforming mortgage because fees are calculated as a percent of the mortgage balance. There are also extra closing costs for this type of mortgage, such as a number of property appraisals.

Because the lenders of non-conforming loans are private, any of the guidelines, except loan limit, are made at their discretion. For that reason, you may be able to secure this type of loan even if you have had a bankruptcy.

Alternative to Non-Conforming Loans

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

  • Loans must be for $510,400 or less in 2020, and for $548,250 or less in 2021.
  • The down payment may be as low as 3% 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 620.
  • In most cases, the debt-to-income ratio must be no higher than 50%, although some lenders use 43% as a common threshold figure.

Conforming loans have some perks over non-conforming loans:

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

Key Takeaways

  • A non-conforming loan falls outside the rules prescribed by Fannie Mae and Freddie Mac.
  • This type of loan is also called a jumbo mortgage because of its size.
  • Private lenders issue these types of loans and make their own rules.
  • To obtain a non-conforming loan you need a nearly perfect credit history.