What is a Non-Conforming Loan?
Non-conforming loans are loans that don’t check all the boxes necessary for the bank to fund them. There is a long list of potential reasons why a non-conforming loan may not meet all the traditional loan criteria, including the following:
- Insufficient credit
- With mortgage loans, the loan amount is higher than a conforming loan limit
- Use of the loan for unconventional purpose(s)
- Non-conforming loans are used when traditional loans won’t meet the borrower’s needs.
- They come with high risk and are costly.
- All traditional loan options should be explored before using a non-conforming loan.
Understanding Non-Conforming Loans
Mortgage loans comprise the majority of non-conforming loans. Typical reasons for a non-conforming loan include the property not being up to the lender’s code or the borrower lacking the credit score or financial capacity that would make them good candidates for borrowing.
Non-conforming loans are quite often offered by hard money lenders. It means that – since they are considered higher risk loans – they carry a much steeper interest rate. For example, with average 30-year fixed-rate mortgage interest rates running just over 4% as of early 2019, a hard money lender may demand up to an 8% interest.
Of course, the benefit for the borrower is that they can get the funding they need. They can also usually secure funds in a timely way, as hard money lenders process loans significantly more quickly than traditional lenders do.
The danger for a borrower taking out a non-conforming loan is that if the housing market declines, then the borrower may end up being “upside down” in his mortgage – owing more than the equity value of the home, and unable to sell it for an amount that will allow him to pay off his mortgage loan.
Example of a Non-Conforming Loan
One of the most common types of non-conforming loans is a jumbo loan. The jumbo loan is a mortgage that goes way beyond the guidelines for the maximum loan amount in accordance with the rules established by the Housing and Recovery Act (HERA) of 2008 and the Federal Housing Finance Agency (FHFA). The lender doesn’t receive protection should the borrower default, as jumbo loans cannot be purchased by or guaranteed by Freddie Mac or Fannie Mae.
Jumbo loans (or non-conforming mortgages) may come with either an adjustable or fixed interest rate. They should really only be used if:
- The borrower has excellent credit
- The borrower has a steady means of income
- The borrower has exhausted all traditional loan options
Choosing a Non-Conforming Lender
The rules for selecting a good non-conforming lender are very similar to those for choosing a hard money lender. Things to look for include:
- The best rates available
- An individual/group with a lot of experience
- Individuals/groups that are willing to negotiate rates and deals
- Positive references from other borrowers
Don’t act in haste. Make sure that the lender is asking the right questions, and that there is an open line of communication.
Conforming Loans and Their Benefits
The important aspect of a conforming loan is that it meets the key criteria that enable the bank or another major lender to issue it. At the very top of the list of criteria is the limit. It is the maximum loan amount that the lender will offer.
In 2008, the US Congress passed the Housing and Economic Recovery Act (HERA), which made it necessary for the conforming loan limit for mortgage loans to change each year, in conjunction with average U.S. home costs. As of 2019, the FHFA raised the conforming loan limit to around $485,000. If a home is in a higher-priced market (think San Francisco or New York City), then the loan limit may be higher.
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