Non-Conforming Loan: What It Is And How It Differs From A Conforming Mortgage
There’s a lot of vocabulary in the mortgage process, and understanding it can be crucial when buying a home. For example, a potential buyer might consider getting a non-conforming loan to purchase a home. But what does “non-conforming” mean and why does it matter?
Non-conforming loans are any loan that doesn’t meet the guidelines set out each year by the Federal Housing Finance Agency (FHFA). A loan that is non-conforming can’t be resold on the secondary mortgage market as securities or similar financial products.
There are a number of non-conforming loans that might be right for you or your situation. Let’s look at conforming versus non-conforming loans and the different types of non-conforming loans you might use to buy a home.
What Is A Non-Conforming Loan?
Non-conforming loans do not follow the guidelines of Fannie Mae or Freddie Mac. Each year the FHFA decides on conforming loan limits based on the data from the previous year. We’ll talk more about loan limits below.
If a loan is non-conforming, that means it doesn't meet the criteria to be bundled and sold to Fannie or Freddie. They are the biggest buyers of mortgage-backed securities and can’t buy non-conforming loans.
The most common types of non-conforming loans are government-backed mortgages. For example, Federal Housing Administration (FHA) loans, U.S. Department of Agriculture (USDA) loans and Department of Veterans Affairs (VA) loans are all non-conforming loans. Another kind of non-conforming loan is a jumbo loan, which is a mortgage that is above Fannie Mae and Freddie Mac limits.
But what makes a loan non-conforming? The reasons a loan is considered non-conforming can vary but might include:
- Lower minimum credit requirements
- Lower minimum down payment requirements
- Higher debt-to-income ratio (DTI) allowances
- High loan limits (for jumbo loans)
Government loans might be a good choice for you if you qualify for one since some conforming loans have stricter qualifications. Meanwhile, jumbo loans can help you get a mortgage higher than the conforming limit. This can be especially helpful if you live in a high-cost area where homes can be more expensive.
Conforming Vs. Non-Conforming Loans
The best way to understand what’s different about a non-conforming loan is to compare it to a conforming loan.
A conforming loan is one that meets the requirements to be sold to Fannie Mae or Freddie Mac. Lenders bundle and sell mortgages to these government-sponsored enterprises (GSE) to increase their liquidity. This allows mortgage lenders to have more funds and be able to finance additional mortgages for home buyers.
In order for a mortgage to be sold to one of these investors on the secondary mortgage market, the loan must meet certain rules set by the FHFA. These rules are what differentiate between conforming and non-conforming loans. Let’s take a look at the rules below:
Loans can’t be sold to GSEs on the secondary market
Can be sold to GSEs on the secondary market
Loan amounts may exceed conforming loan limits
Loan amounts are at or below the conforming loan limits
Less strict eligibility requirements
More strict eligibility requirements
Lower down payment requirements
Higher down payment requirements
2023 Loan Limits
The first big difference between a conforming and a non-conforming loan is the loan’s limit, which varies by state and county. Below are the conforming loan limits for 2023.
- For the lower 48 states, the maximum amount on a regular loan for a one-unit property is generally $726,200.
- For Alaska, Hawaii and certain high-cost areas, the maximum is $1,089,300.
- If you’re buying a multiunit home, higher limits do apply.
- Anything above county limits is a jumbo loan and is considered non-conforming.
To get a conforming loan, you must meet the credit guidelines of the agency that’s buying the loan. For example, in 2023 Fannie Mae and Freddie Mac will accept a median FICO® Score of 620 or higher for a fixed-rate loan. A non-conforming loan, like one offered by the FHA, can have a score as low as 580 or even 500 with some lenders.
Conforming loans require a DTI below 50%. Non-conforming loans vary with respect to this requirement. This can vary quite a bit for conforming loan types.
For example, a jumbo loan typically requires a lower DTI since lenders want to know you have the funds available to pay back a large loan. In contrast, you may be able to get an FHA loan with a higher DTI since it’s backed by a government agency.
Your loan-to-value ratio (LTV) affects your down payment. For conforming loans, you’ll need an LTV of no more than 97%, which equates to a 3% down payment. Again, this can vary for non-conforming loans.
A jumbo loan typically requires a higher down payment, usually around 20%. In contrast, most government loans will have a relatively low LTV requirement. For example, an FHA loan allows an LTV of up to 96.5% and VA loans usually offer LTV of up to 100%.
Types Of Non-Conforming Loans
Non-conforming mortgages can be broken down into a few different types of loans. Let’s review the most common ones below.
Government home loans are backed by the federal government. When it comes to these loans, mortgage lenders are referring to those insured by the FHA, USDA and VA. Each of these mortgages come with their own respective requirements and benefits.
FHA loans offer low interest rates and less strict credit score requirements. They also require a:
- Minimum down payment of 10% for borrowers with a FICO® Score between 500 – 579
- Minimum down payment of 3.5% for borrowers with a FICO® Score of 580 or higher
- Mortgage payment that can’t be more than 38% of the borrower’s gross monthly income, if certain conditions are met
- DTI no higher than 51% of the borrower’s gross monthly income, in some cases
USDA loans are a popular home loan option due to their no down payment requirement, competitive rates and closing costs that can be rolled into the mortgage. This government loan uses the following requirements:
- Minimum FICO® Score of 640 or higher with most lenders
- Property must be located in an approved rural area or suburbs
- Household income must be below 115% of the area median
VA loans come with many benefits, including no down payment requirement and lower interest rates. However, they do require a special origination fee called a VA funding fee and borrowers have to meet the following criteria:
- No minimum credit score is required by the VA
- Available for eligible active-duty service members, reservists, veterans and surviving spouses of those who passed in action or as a result of a service-connected disability
- Property must be used as a primary residence within 60 days of purchase
Another common type of non-conforming loan is a jumbo loan, which comes with higher loan limits.
The good news is that jumbo mortgages typically come with similar rates to any other loan. There are just a couple of requirements you’ll need to meet:
- Your DTI must be lower than it would be on a regular loan (45% is our starting point).
- You’ll need a down payment greater than 10% of the purchase price.
- We require a minimum median FICO® Score of 680.
- Your lender may require additional documentation due to the size of the loan.
The Pros And Cons Of Non-Conforming Loans
Trying to figure out which loan is right for you? Here’s how non-conforming mortgages stack up to conforming loans.
When it comes to non-conforming loans, there are three big benefits:
- Higher loan amounts are available (jumbo loans).
- Depending on the loan option, you might be able to buy different types of property than you could with a standard conforming loan.
- You might be able to get some kind of non-conforming loan if you have a negative mark on your credit, like a recent bankruptcy.
Unlike conforming loans, non-conforming loans:
- Are offered by fewer lenders, which may limit your ability to shop around
- May come with a higher interest rate, if you’re not using a government loan
- Have less standardization from lender to lender
The pros and cons of each loan type may vary slightly. Ultimately, the best type of loan for you is based on your personal situation and the property you’re buying. If you’re not sure of your options, you can talk to your mortgage lender.
Non-Conforming Loan FAQs
We’ve answered a few of the most commonly asked questions regarding non-conforming mortgage loans below.
Can you refinance a non-conforming loan?
Most loans are eligible for refinancing, including non-conforming loans such as FHA or VA streamlined refinance options. If you’re looking to refinance your mortgage for extra cash or to switch your non-conforming loan to a conforming loan, you’ll need to start by finding a qualifying lender who can help you through the process.
Is a conforming or non-conforming loan better?
Choosing between a conforming or non-conforming loan depends on your personal financial situation and which option is best for your needs. Non-conforming loans may help you buy a home with no down payment (if you qualify for a VA loan) or afford more expensive homes through government-backed loan programs. But, conforming loans have benefits too – like lower mortgage rates for borrowers with strong credit scores.
Can you use a non-conforming loan to buy a second home?
While you can use some non-conforming loans to purchase a second home, most government-back mortgages do have occupancy rules. This means you’ll need to spend a significant amount of time each year in this home in order to qualify it as a second residence. Otherwise, you are limited to 14 days of renting to another tenant. However, FHA loans would not qualify.
Is a conventional loan conforming or non-conforming?
A conventional loan is simply a mortgage that isn’t backed by a government agency. That means it can either be conforming or non-conforming, depending on its loan amount. For instance, if you take out a conventional mortgage for $730,000, your loan would be non-conforming because it exceeds the conforming loan limit of $726,200. On the other hand, if the loan is for $600,000, then it could be considered a conforming loan.
The Bottom Line: Non-Conforming Loans Offer Many Benefits
While “non-conforming” might initially sound negative, all it means is that your loan won’t be purchased by Fannie Mae or Freddie Mac. For many home buyers, non-conforming loans are a way to secure a loan outside of typical conforming requirements. You’ll need to pick a home loan that works for you based on your circumstances and home buying needs.
Ready to see your personalized loan options? Get started online to find out more and determine the best choice for you.