What Are Nonconforming Loans?

A nonconforming loan does not adhere to Fannie Mae and Freddie Mac guidelines, preventing the lender from selling the mortgage to these entities and removing it from their books.

You've dreamed of buying a home, but now a mortgage stands in your way. You're one of thousands of borrowers who might need to consider a nonconforming loan. The good news? Nonconforming loans don't need to meet the guidelines of government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac, which means lenders can be more lenient. As with any other mortgage product, there are pros and cons. Read on to understand common types of nonconforming loans and learn how to choose the best option for your needs. 

What Are Nonconforming Loans?

A nonconforming loan, in contrast to a conforming loan, does not meet Fannie Mae and Freddie Mac guidelines, and therefore, the lender cannot sell the mortgage to them and remove it from their books. 

Because a nonconforming mortgage does not meet the Fannie Mae or Freddie Mac guidelines, it cannot be sold to them. Government-Sponsored Entities (GSE) guidelines for conforming loans include a loan maximum, types of suitable properties, down payment minimums, credit requirements, and other factors. 

That's good news for you as a buyer, as it means you could qualify for a mortgage on a property that is too costly, needs major repairs, or has other issues. Likewise, you could still qualify for a nonconforming loan if you don't meet income, debt-to-income (DTI), credit score, or other conforming loan requirements. 

How Does a Nonconforming Loan Work?

Nonconforming mortgages are a good choice for borrowers who cannot meet standard loan requirements. They are not typically more difficult to apply for, and they're not usually more risky than conforming loans.

The main difference between a conforming or nonconforming loan is what happens after you secure the mortgage. When a bank or other financial institution issues a mortgage, they typically do not keep it. Instead, they sell it to a government-sponsored entity or private investors. 

Government-sponsored entities have federal rules to assist in purchasing loans with lower overall risk. Banks like these conforming mortgages because they will readily sell. 

Lenders may find nonconforming loans more difficult to sell. As a result, they may charge higher interest rates or fees to compensate for the additional risk of retaining the mortgage for longer. 

While private banks underwrite most mortgages, conforming loans usually end up in Fannie Mae's and Freddie Mac's portfolios when they buy loans from banks and package them into mortgage-backed securities (MBS). These MBSs are sold on the secondary market as asset-backed securities (ABS).

The asset-backed securities are secured by mortgages and can be sold to various private financial companies. These companies, including Fannie Mae and Freddie Mac, buy, package, and resell mortgage-backed securities. When banks sell mortgages, it frees up capital to invest in offering new loans at the current interest rate. 

Who Should Consider Applying for a Nonconforming Loan?

You should consider getting a nonconforming loan if you have certain requirements that don't fit within conforming loan limits. For example, you'll need a nonconforming loan to buy a property that is up to the lender's code, or if you lack the credit score or financial capacity to qualify for a conforming loan. Reasons to get a nonconforming loan include:

• Property costs exceed conforming loan limits.
• The property needs major repairs that disqualify you from a conforming loan.
• You have irregular income, no down payment, high debt, or other financial situations that make qualifying for a conforming loan difficult. 

Types of Nonconforming Mortgages

There are various types of nonconforming loans to choose from, including:

1. Government-Backed Loans

These loans are 

• FHA home loans: Designed for lower-income borrowers, you could qualify for an FHA loan with as little as 3.5% down payment. You'll need a credit score of at least 580 unless you have a down payment of 10%; then you could qualify with a score as low as 500. 
• USDA home loans: USDA loans are available to borrowers purchasing in qualified rural areas. You'll usually need a minimum credit score of 620 to qualify. 
• VA home loans: Only available to qualified service members, veterans, and military spouses, VA home loans come with the possibility of lower interest rates, and no minimum down payment. You'll need a minimum credit score of 620. 

2. Jumbo Mortgages

Jumbo loans exceed current conforming loan limits. For 2024, the maximums for conforming loans are $766,550, or $1,149,825 in certain high-cost areas. In most cases, you'll need a minimum credit score of 700 and may need a higher down payment 

3. Interest-Only Mortgages

With an interest-only mortgage, you'll pay only the interest and won't start repaying the mortgage principal for a set period. This is helpful for borrowers who are building new income streams or expect career growth. Interest-only mortgages can also be helpful if you need extra capital for home renovations or repairs. Interest-only mortgage lenders can help guide you through the application process and may have varying credit score and/or down payment criteria. 

4. Purchase-Money Mortgages

A purchase-money mortgage, also known as seller financing, allows you to take over the seller's existing mortgage. This is especially favorable in times of high interest rates, as you could purchase a home with a fixed interest rate lower than you could otherwise qualify for. You'll need to meet the existing mortgage lender's qualification criteria and may need to take a second mortgage for the difference between the existing mortgage and the sale price. 

5. Holding Mortgages

A variation on seller financing, a holding mortgage is a nonconforming loan in which the seller acts as the lender and retains the property title. You will then make monthly payments directly to the owner. This carries additional risk for both the seller and the borrower, so it's essential to work with real estate lawyers to get the terms in a written contract. 

6. Hard-Money Mortgages

While not usually issued by banks or financial institutions, you can also consider a hard money mortgage. These nonconforming, asset-based loans are issued by private investors or companies. You receive the capital secured by the property. 

Pros and Cons Nonconforming Mortgages

There are significant pros and cons to nonconforming mortgages. Here's what to weigh before choosing this type of loan. 

Pros

• Qualification: It can be easier to qualify for nonconforming mortgages. 
• Low down payment: You could qualify for a mortgage with a 0% to 3.5% down payment, making it easier to buy a home without significant savings. 
• Access to capital: A nonconforming mortgage allows you to buy a home just as you would with a conforming mortgage. 

Cons

• Interest rates: Nonconforming loans often have higher interest rates than conforming loans. 
• Fees: In some cases, you'll have to pay extra fees for the convenience of nonconforming loans. 
• Limits: Some conforming loans, such as government-backed loans, limit property location, income, or military status. 

Find the Best Nonconforming Loans From Benzinga’s Top Providers

Ready to buy? You can find the best nonconforming loans from Benzinga's top lenders here:

Should You Get a Nonconforming Loan?

Certain nonconforming loans, including VA, USDA, and FHA loans, offer attractive terms like low down payment requirements and the possibility of lower interest rates. In fact, the only real downside of a nonconforming loan is higher interest rates and fees. That's why it's essential to carefully compare lenders and get prequalified with multiple lenders to find the best available terms. 

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