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What Is a Non-Conforming Mortgage Loan? And How Does It Affect You?

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If you’ve been doing some mortgage shopping/research lately and happened to come across the phrase “non-conforming loan,” you might have some questions.

At first glance, you probably understand that the loan in question doesn’t conform, but to what exactly?

Well, what they mean is that it doesn’t adhere to the standards of Fannie Mae and Freddie Mac, which together back the majority of mortgages in the United States.

The pair essentially keep the mortgage market liquid by buying the loans lenders originate, or by packaging them into mortgage-backed securities (MBS).

But if your particular loan doesn’t meet their underwriting criteria for one reason or another, it does not conform and therefore can’t be backed or purchased by them.

As such, there’s a good chance it’ll be more difficult to find financing, and potentially more expensive as well, essentially because there are fewer lenders willing to fund your loan.

For the record, many lenders only originate conforming loans, so your options can shrink in a hurry if your loan is non-conforming.

Why Are Mortgages Deemed Non-Conforming?

non-conforming loan

  • A loan is non-conforming if it doesn’t meet Fannie Mae or Freddie Mac’s guidelines
  • There are numerous loan requirements that must be met
  • Including maximum loan amounts, which vary by area/property type
  • Mortgages that exceed these limits are known as jumbo loans

The most common reason for a mortgage to be non-conforming is loan amount.

Fannie Mae and Freddie Mac only accept loans up to a certain size, known as the conforming loan limit.

This limit can change annually in January, which it recently did thanks to rising home prices, as measured by the Federal Housing Finance Agency (FHFA).

As of 2019, this limit is $484,350 for a one-unit property in the contiguous United States. Now the 2020 conforming loan limit is $510,400.

To give you some perspective, it increased $31,250 from 2018, so it can rise quite a bit from year-to-year if home prices perform well in the preceding 365 days.

Now, it gets a little bit more complicated because there are different loan limits based on location and property type, and even so-called high-cost loan limits in certain parts of the country that are more expensive.

For example, while the loan limit is technically $484,350 nationwide, home buyers in Los Angeles county can get a conforming mortgage backed by Fannie/Freddie for up to $726,525.

Additionally, if the property happens to be located in Alaska, Guam, Hawaii, or the U.S. Virgin Islands, the max loan amount can be the same $726,525 because they enjoy higher limits.

But wait, there’s more! If the property is a duplex, triplex, or fourplex, the max loan amount can be $930,300, $1,124,475, or even $1,397,400, respectively.

Simply put, Fannie and Freddie will back your home loan even if it’s massive. Of course, loan amount is just one factor that determines whether the loan is conforming or non-conforming.

But anything above these limits is known as a jumbo loan, which by definition makes it non-conforming.

What Other Factors Make a Loan Non-Conforming?

  • There are other possibilities why a loan might not conform
  • Including a credit score below 620 or an LTV that is too high
  • Along with other potential borrower/property-related issues
  • Or certain loan types like interest-only mortgages and stated income loans

Generally, Fannie Mae and Freddie Mac only offer mortgages to borrowers with FICO scores of 620 and higher.

So if you don’t have a credit score that high, but still need a mortgage, you’ll either need to turn to a government loan (FHA, VA, or USDA) or a non-conforming loan.

Assuming a government loan doesn’t work for whatever reason, you may need to seek out a loan from a lender that isn’t selling your loan to Fannie Mae or Freddie Mac, which most do.

As mentioned earlier, if they aren’t doing business with Fannie and Freddie, there’s a decent chance your mortgage rate will be higher, all else being equal.

The reason is that conforming loans are the most marketable because there’s always a buyer, whereas non-conforming loans may stay in the lender’s portfolio or be sold off to only certain investors.

Of course, there are exceptions to the rule, and some jumbo loans may price lower than conforming loans.

Anyway, other reasons a loan might be non-conforming include loan-to-value (LTV) ratio. Fannie Mae has an eligibility matrix that lists maximum LTVs based on transaction type and property type.

For example, they allow a max LTV of 97% for a one-unit purchase or rate and term refinance, which is pretty liberal. That calls for a mere 3% down payment.

But what if it’s a cash-out refinance on a two-unit property? Well, the max LTV drops to 75%. Maybe you want/need a loan up to 80% LTV. If so, you might have to take out a non-conforming loan with a lender willing to exceed those limits.

The same can go for borrowers with debt-to-income ratios (DTIs) that exceed certain limits, generally 50% or lower, interest-only loans, or stated income loans.

Additionally, if the borrower experienced a short sale or foreclosure and not enough time has gone by, a non-conforming loan might be the only available option.

There can also be property-related issues that make a home loan ineligible for delivery to Fannie and Freddie.

One common example is a non-warrantable condominium, which may earn that distinction for a variety of reasons.

Either one entity owns too many units in the complex, too many are rented out, or the HOA itself has issues of some kind like an ongoing lawsuit or too many existing owners are delinquent on their dues.

In short, if the property doesn’t pass muster, you may have to go the non-conforming route and find a lender willing to overlook some of those things.

Again, this will likely come at a cost because said lender will charge more to allow such concessions, which are generally deemed higher-risk.

To summarize, there are options for borrowers with non-conforming loans, but in most cases you’ll probably obtain a lower interest rate if your loan is conforming, though it won’t always be in your control.

Commonly Asked Questions

What makes a loan non-conforming?

It doesn’t meet the underwriting standards of Fannie Mae or Freddie Mac, either because of loan amount, credit score, LTV, DTI, property type, and so on.

This might include borrowers with FICO scores below 620, jumbo mortgages, interest-only mortgages, or mortgages on certain condominium complexes and unique properties.

Is non-conforming and jumbo the same?

No. A loan can be below the conforming loan limit and non-conforming for other reasons, such as low credit score, high DTI, high LTV, etc.

Are there non-conforming loan limits?

Nope. Lenders can set their maximum loan amounts as they wish because they are either keeping the loans in their own portfolio or selling them to investors who are OK with their guidelines.

Are there specific non-conforming loan requirements?

Again, no. Because lenders set their own rules, they can come up with their own individual requirements that can vary tremendously based on risk appetite.

Some may allow loan amounts of $5 million or higher, while others may only go as high as $1 million. Same goes for credit scores, DTIs, and so forth.

Is an FHA loan a conforming loan?

No, it’s a government loan, similar to VA and USDA loans, also known as non-conventional.

Who are the non-conforming lenders?

There are too many to list, and many lenders originate both conforming and non-conforming loans, including large banks and smaller non-banks.

Some lenders specialize only in non-conforming loans, often referred to as non-QM lending.

A mortgage broker may also work with non-conforming lending partners if you need help with loan placement.

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