Conforming and nonconforming loans: What’s the difference?

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Conforming loan? Nonconforming loan? You might be baffled by these bits of mortgage jargon. Both can help you purchase the property you’re interested in, but there are important differences between the two, and if you’re in the market to secure a mortgage, it’s critical to have a solid grasp on them before you make a choice.

What is a conforming loan?

A conforming loan is one that meets the guidelines set by government-backed agencies such as Fannie Mae and Freddie Mac. There are a number of criteria that must be met to qualify for a conforming loan, including the amount you’re borrowing.

For 2020, the ceiling for a single-family, conforming home loan is $510,400 in most parts of the continental U.S. In Hawaii and Alaska, and in certain high-cost counties where median home prices are significantly higher than average, the conforming loan limit goes up to $765,600. You can find state-by-state loan limits here.

There are other criteria that a conforming loan must meet, as well. They include specifications about the size of the down payment relative to the loan, the borrower’s debt-to-income ratio, the type of property and the borrower’s credit score and history.

Typically, conforming loans require a minimum credit score of 630­ to 650 (although getting the best rate requires a score of 740 or higher), a minimum down payment of 3 percent and a debt-to-income ratio no higher than 41 percent.

Thanks to these requirements, investors see conforming loans as less risky investments. Because there is a larger secondary market for conforming loans, they often have lower interest rates — and that can mean lower monthly payments and less money spent over the lifetime of the loan.

What is a nonconforming loan?

Mortgage loans that don’t meet the requirements for a conforming loan are considered to be nonconforming loans. “Jumbo loans” are nonconforming loans that exceed the maximum loan limit for an area — but loans can be nonconforming for other reasons beyond loan size. For example, many loans for commercial properties are nonconforming.

Compared to conforming loans, there is a much wider diversity of loan types and features among nonconforming loans. It’s important to remember that nonconforming mortgages often come with higher interest rates than conforming loans, although this is not always the case. The process of securing a nonconforming loan may also be quicker and require less documentation.

Particularly in the case of jumbo loans, lenders may expect to see borrowers with higher down payments, higher credit scores, high cash reserves and/or lower debt-to-income ratios in order to justify the size of the loan. You can expect to put down a down payment of at least 20 percent if you’re planning to rely on a nonconforming loan. You can research jumbo loan rates here.

Nonconforming loans may also be available to borrowers who have gone through a bankruptcy in the recent past, which may disqualify them from a conforming loan.

Three common reasons borrowers don’t qualify for conforming loans:

  • Loan size: If you’re borrowing more than $510,400 in much of the U.S., or more than $765,600 in high-cost areas such as Northern California, you’ll need a nonconforming loan. Less than that and a conforming loan will do.
  • Credit score: If you’ve experienced credit troubles and your FICO score is south of 630, you probably won’t qualify for a conforming loan. For borrowers with low credit scores, mortgages issued by the Federal Housing Administration are a popular alternative. FHA loans allow for down payments as low as 3.5 percent. One downside: Steep fees for mortgage insurance make FHA loans costlier than conforming loans.
  • A high debt-to-income ratio: If your debts push you out of Fannie and Freddie territory, you still might be able to get an FHA mortgage or a type of nonconforming loan known as a non-QM mortgage.

Shopping for a nonconforming loan

If you’ve decided that a nonconforming loan is the right choice for your situation, make sure to do your homework before selecting a lender. Compare interest rates and loan terms among several different lenders to ensure you find the best option.

You can contact your bank and other lenders directly to ask them about the types of nonconforming loans they offer. Another avenue worth exploring: Find a mortgage broker who specializes in nonconforming loans. A good broker knows what’s available and can save you time and money.

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