What Makes a Mortgage Non-Conforming?

There are a number of terms that float around the mortgage world that can be important to understand before you go to apply for a mortgage. If you missed our post on Decoding Mortgages, you definitely want to check that out. In this post, we’ll cover conforming versus non-conforming mortgages. There are a number of things that create the distinctions between them.

The main difference between a conforming and non-conforming loan is the ability for the lender to turn around and sell the loan once they have furnished it. Most mortgages will be sold to Fannie Mae or Freddie Mac (government sponsored entities), but some are sold to other secondary investors. Very few banks will keep the loan in house long term. In the case of selling the loan, if the terms of the loan don’t fall within certain parameters, investors won’t buy it.

Conforming loans are the loans that fall within those certain parameters that make it most likely that investors will buy the loan from the bank. Non-conforming loans don’t meet the criteria, and are more likely that the bank will be stuck holding the loan themselves. If the bank can’t sell the loan, they have to rely on your payments to earn their money back (and hope that you pay them), rather than getting a lump sum like they would with a sale of a loan. Since non-conforming loans carry more risk to the bank, banks will often require more from the lendee than they would for a conforming loan. This might be in the form of a higher downpayment minimum, or it might be a higher interest rate.

There are two main things that might require a non-conforming loan. One, is if the loan amount is higher than the maximum allowed by FHFA (The Federal House Finance Agency, i.e. the agency that houses Fannie Mae and Freddie Mac). The limit increases most years and is higher in certain expensive areas, but generally speaking, is a little under $500,000 right now. If you are seeking a loan higher than the limit, then the banks likely won’t be able to sell the loan, and will then require a non-conforming loan. This will often be referred to as a Jumbo loan.

The second thing that might make a loan non-conforming is the proprty type. Fannie Mae and Freddie Mac have certain conditions that must exist in order for the loan to be purchasable. For example, when I purchased my first condo, 2 units in the building were owned by the same person, which automatically put the building into an investment property category, making it unsellable to Fannie Mae and Freddie Mac. They have since changed the guidelines, so that same property would be eligible today, but the rules are always changing, so check them out if you are in the market.

As the home buyer, the difference to you is in the terms of the loan. A non-conforming loan will usually require a better credit score, a larger downpayment (usually 20%) and a higher interest rate (I have typically seen an additional .5%). If the property you are after doesn’t fit a conforming loan model, then a non-conforming loan may be your only option, so hopefully it’s worth the extra expense.