What Are Non-Conforming Loans?

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March 20, 2023

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Data from Zillow shows that the average home value in Tampa is nearly $417,000 – up 17.5% from 2021. Real estate is more expensive than ever, so most homeowners need financial assistance from lenders during the home-buying process.

When speaking to mortgage lenders, you’ll find two main loan options: non-conforming and conforming loans. What are non-conforming loans, and how do they differ from conforming loans? Read on to find out.

What Is a Non-Conforming Loan?

A non-conforming home loan is a loan that doesn’t meet the rules of Fannie Mae and Freddie Mac. The most common types of non-conforming mortgages are government-backed.

Non-Conforming Loan Requirements

You can qualify for a non-conforming mortgage with a lower credit score than other loans. Although the qualifying credit score varies by lender, many accept a score as low as 580.

You also typically need a debt-to-income ratio (DTI ratio) of 50% or below.

Additionally, these loans usually have a lower down payment requirement than conventional ones.

However, it’s important to note that with less stringent eligibility, a non-conforming loan often comes with higher interest rates.

Non-Conforming Loan Benefits

One of the most significant benefits of a non-conforming mortgage is that home buyers can take out a larger mortgage because they have higher maximums. This is especially useful for buyers living in high-cost areas.

Another benefit is eligibility with a lower credit score or higher DTI ratio. This allows more potential homeowners to secure a mortgage. Finally, lower down payment requirements lessen the barrier to entry into homeownership for lower-income individuals.

Types of Non-Conforming Loans

There are several different non-conforming home loans a borrower may consider. However, here are the four most common.

Jumbo Loans

Jumbo loans have a loan size that is much larger than conventional loans. Of the four options here, jumbo mortgages are the only ones that aren’t government-backed loans.

FHA Loans

The Federal Housing Administration (FHA) loan program is popular with first-time homebuyers because the lower credit score requirement is lower, and the minimum down payment is only 3.5%.

Borrowers with a score as low as 500 can qualify for a home purchase with an FHA loan if they make a down payment of 10%.

VA Loans

The U.S. Department of Veterans Affairs insures VA loans. These loans are available for the following:

  • Active Duty Service Members
  • U.S. Armed Forces Veterans
  • Certain Reservists and National Guard Members
  • Certain surviving spouses of deceased Veterans

VA loans have no minimum down payment. Instead, the VA requires the mortgage lender to review the complete loan profile.

USDA Loans

The government offers USDA loans to help low and very-low-income Americans, particularly in rural areas. The program provides payment assistance to help improve the borrowers’ ability to repay.

The assistance from a USDA loan depends on the adjusted family income.

What Is a Conforming Loan?

A conforming or conventional mortgage is any mortgage that meets the standards set out by Fannie Mae and Freddie Mac. The Federal Housing Finance Agency (FHFA) issues the rules for these loans.

Conventional loans have a borrowing limit. The FHFA announced the conforming loan limit for 2023 is 150% of $726,200 or $1,089,300. Certain places, like Hawaii and Alaska, have slightly different limits.

Higher limits apply when buying a multi-family home, like a condo building, but not all buyers qualify for these purchases.

Conforming Loan Requirements

The underwriting process for conforming loans has stricter requirements on the maximum loan amount, credit requirements, and the types of properties you can purchase.

Typically, conforming loans require a minimum credit score of 620 and a DTI ratio of 43% or below.

Conforming loans also require a loan-to-value (LTV) ratio of no more than 97%. The LTV ratio shows the difference between the loan amount and the property’s current market value.

Conforming Loan Benefits

Conventional loans often have lower interest rates, and these rates are usually fixed. Thus, your rate will remain the same even if the government raises interest rates. Conversely, many non-conforming mortgages have adjustable rates that fluctuate with the market and could cost more than expected.

Further, after you have 20% in your home, you won’t need to pay for mortgage insurance. And because of the stricter qualifications, those who take out a conforming loan are less likely to face foreclosure.

This makes conforming loans great for single-family home purchases.

How Lenders Service Conforming Loans

Many different lenders offer conforming mortgage loans. But your mortgage doesn’t stay with your lender while you pay it back. Instead, Freddie Mac and Fannie Mae buy loans from lenders. This gives lenders a constant flow of money. Lenders would not have the capital to continue lending without the cash flow.

Thus, Freddie and Fannie bundle your mortgage with similar mortgages and sell them as mortgage-backed securities (MBS) on the secondary mortgage market. They don’t offer direct loans to customers. Instead, their goal is to meet consumer protection requirements.

Freddie Mac

The government created the Federal Home Loan Mortgage Corporation (FHLMC), better known as Freddie Mac, in 1970 as part of the Emergency Home Finance Act. Congress wanted to expand the secondary mortgage market.

It’s a government-sponsored entity (GSE) that provides liquidity, stability, and affordability to the housing market.

Fannie Mae

The Federal National Mortgage Association (FNMA), also known as Fannie Mae, is another GSE. Congress founded it in 1938 to offer more affordable housing to Americans.

Before Fannie Mae, home buyers had to put down a 50% down payment, and one missed payment could result in foreclosure. As a result, homeownership was incredibly difficult for everyday Americans.

However, after the 2008 financial crash, the New York and Chicago stock exchanges delisted Fannie Mae and Freddie Mac to give more control back to the government.

Non-Conforming Loans vs. Conforming Loans: What’s the Difference?

As you learned in this post, the most significant differences between non-conforming and conforming loans are the following:

  • Borrowing capacity
  • DTI ratio
  • Minimum credit score
  • Mortgage rates

Although conforming loans have lower interest rates and high eligibility requirements, non-conforming home loans are more accessible to those with unfavorable credit or who need to borrow more.

Importantly, you can usually refinance both types of loans if necessary.

Apply for a Home Loan Today

If you’re currently in the home-buying process, apply for a home loan today from The Associates Home Loan of Florida. We have our NMLs licensing and are experts at guiding you in the loan process. You can feel confident obtaining your loan through us!

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