What are non-conforming loans?

A non-conforming mortgage is just one of several types of home loans. It’s called “non-conforming” because the borrower qualifying standards or structure fall outside conforming criteria that allows two major government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, to buy the loan. Here’s what that means — and when you might want to explore non-conforming mortgage lenders for yourself.

What are non-conforming loans?

Non-conforming mortgages are a type of home loan that don’t meet some or all of the guidelines making them eligible for purchase by Fannie Mae and Freddie Mac. These GSEs support much of the mortgage market in the U.S.

A loan could be labeled as non-conforming for any number of reasons. Most commonly, you’ll see non-conforming loans because:

• The amount of the loan exceeds conforming loan limits ($726,200 in most parts of the U.S. in 2023).
• The borrower’s credit score and debt-to-income (DTI) ratio aren’t within conforming qualifying standards.
• The loan has a non-traditional structure, such as an interest-only mortgage or a term other than 15 years or 30 years.

How does a non-conforming mortgage work?

Many mortgage lenders offer non-conforming loans, and some even specialize in them. When you borrow from these non-conforming mortgage lenders, the loans work in much the same way as a conforming loan in that they allow you to borrow money to buy a home.

So, what are non-conforming loans set apart by? Fannie Mae and Freddie Mac cannot purchase non-conforming mortgages from lenders and package them for investors. Typically, the capital derived from these sales helps lenders continue to offer more mortgages.

For this reason, lenders tend toward conforming versus non-conforming loans. In other words, they prefer conforming loans because they can be easily pooled into investment bundles and sold on the secondary mortgage market. Because they can’t sell non-conforming loans to the GSEs, lenders often keep these on their books, which requires more work to underwrite.

For you as the borrower, the lack of GSE backing isn’t necessarily cause for concern; there are some non-conforming loans that are backed by other government agencies instead of the GSEs. The non-conforming loans without backing, however, might present risks.

Types of non-conforming loans

To help yourself avoid one of those less-than-ideal non-conforming mortgage lenders, look closely at how the financial institutions behind non-conforming loans work. Your options include:

Government-insured loans

A government-insured mortgage is one backed by either the Federal Housing Administration (FHA loans), the U.S. Department of Veterans Affairs (VA loans) or U.S. Department of Agriculture (USDA loans). These aren’t eligible for Fannie Mae or Freddie Mac to buy, but they are backed by their respective agencies, so you can rest assured they’re safe products. Here’s an overview:

• FHA loans: FHA loans allow you to borrow money for a home purchase with a credit score as low as 580 and a down payment of just 3.5 percent — or a credit score of 500 if you put down 10 percent. Unlike some other non-conforming loans, however, you’ll need to pay mortgage insurance premiums with your FHA loan.
• VA loans: VA loans are mortgages for military service members, veterans and surviving spouses. If you’re eligible, you can buy a home with a VA loan for no money down and no requirement to pay mortgage insurance. (Instead, you’ll pay a one-time funding fee.)
• USDA loans: USDA loans are for those buying a home in certain rural areas designated by the government. Like VA loans, you can get a USDA loan with no money down, but you’ll be required to pay some fees.

Jumbo loans

A jumbo loan is one of the most common types of non-conforming loans, though not every lender offers them. These loans are for borrowers in need of a bigger mortgage than what’s allowed with a conforming loan. In most areas in 2023, that means a mortgage for more than $726,200 (or up to $1,089,300 in higher-priced markets). In many places where home prices have risen substantially, a jumbo loan might be the only option for some borrowers.

While jumbo loans tended to have higher interest rates than conforming loans, jumbo loan rates have been much lower this year. They can be more difficult to qualify for, however. You might need to put more money down upfront, for example, have a better credit score (typically 700 or higher) and additional assets in the bank.

Other non-conforming loan types

You can find other kinds of non-conforming mortgages, including:

• Hard money loans: A hard money loan is a non-conforming loan providing a borrower with short-term funding. Real estate investors often seek them out because they need money to flip a property, but they might not have the credit or financials on paper to qualify for a more traditional home renovation loan. Hard money loans have higher interest rates and shorter terms, so they’re more expensive and carry more risk.
• Interest-only loans: Interest-only loans are non-conforming because they aren’t structured like conforming loans, which require you to repay both principal and interest as the loan amortizes over time. Rather, with an interest-only loan, you’ll pay just interest initially for a time (e.g., 10 years), after which you’ll repay both interest and principal, sometimes in one lump sum known as a balloon payment. This payment can be unmanageable for many borrowers.
• Owner financing: With owner financing, also called a purchase-money mortgage, the homebuyer pays the seller — rather than a mortgage lender — in monthly installments with an agreed-upon interest rate. Purchase-money mortgages are a type of non-conventional loan in which the seller holds the title to the property while the buyer makes payments toward full ownership of the home.

Who is a non-conforming loan best for?

Non-conforming mortgages are best for those who need a larger loan or otherwise don’t qualify for a conforming loan or conventional loan. This might include borrowers who have a lower credit score or limited or no down payment savings, or those who are real estate investors or self-employed. It might also be the only option for borrowers who need a bigger loan due to high home prices.

Pros and cons of non-conforming loans

Non-conforming loans have their benefits and drawbacks, which include:

Pros of non-conforming loans

• Greater availability based on borrower criteria: If you can’t qualify for a conforming mortgage because you have bad credit, no savings for a down payment or another dark spot on your financial profile, exploring non-conforming loans might give you a path to homeownership.
• Higher loan limits: With non-conforming mortgages, you’re not beholden to any cap on the amount you can borrow.
• More use cases: These loans might allow you to get the money you need for a major house flip or to buy a property a traditional mortgage lender wouldn’t cover.

Cons of non-conforming loans

• Less availability based on number of lenders: While most home lending institutions offer conforming mortgages, the number of lender options drops when it comes to non-conforming mortgages.
• Higher risk: A lot of the criteria laid out to make a loan conforming protect you from borrowing too much and taking on a loan you’re not in a good position to manage.
• Less predictability: Some non-conventional loans — like hard money and interest-only loans — have different mortgage repayment processes. You might be left with serious financial hurdles if you need to repay your money quickly or you face a balloon payment.