Non-Conforming Loans: A Complete Guide

The journey to home ownership comes with a whole host of questions, such as: what is the right type of mortgage for me?

If you’ve heard the term non-conforming loan, you might be worried that it is as inflexible as the name suggests. This is something of a misnomer and in fact, the opposite may be true. Let’s talk about non-conforming loans and the benefits they provide home buyers.

What Is A Non-Conforming Loan?

A non-conforming loan is any mortgage loan that doesn’t satisfy, or “conform” to, the funding requirements of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Non-conforming loans either surpass the conforming loan limit set by the Federal Housing Finance Agency (FHFA) or don’t meet additional requirements that the FHFA sets for conforming loans.

Conforming Vs. Non-Conforming Loans

When talking about non-conforming loans, it can be helpful to know how they differ from conforming loans. Conforming loans satisfy the FHFA’s funding requirements. Because conforming loans adhere to these guidelines, they can be sold to government-sponsored entities (GSEs) like Fannie Mae and Freddie Mac. Non-conforming loans, on the other hand, can’t be sold to these entities.

Non-conforming loans may offer home buyers:

• Higher debt-to-income (DTI) ratio thresholds
• Lower minimum credit requirements
• Smaller down payment requirements
• Higher mortgage loan limits

Understanding How A Non-Conforming Mortgage Works

Because they don’t conform to GSE guidelines, non-conforming loans are typically harder to sell than conforming loans. After a conforming loan closes, the original lender can sell the loan to Fannie Mae and Freddie Mac. These GSEs then hold such loans in their portfolios or bundle similar loans together and package them into mortgage-backed securities (MBS), which are sold on the secondary mortgage market. This frees up lenders to continue underwriting mortgages.

Because non-conforming loans can’t be purchased by GSEs, they’re riskier for lenders. Non-conforming loans must either stay in the original lender’s portfolio or be sold to entities that specialize in purchasing non-conforming loans on the secondary mortgage market.

Types Of Non-Conforming Loans

Non-conforming loans can be broken down into categories. Let’s take a look at the different types of non-conforming loans and their requirements for borrowers.

Jumbo Loans

Jumbo loans exceed the conforming loan limit. For 2024, the conforming loan limit in most areas of the U.S. is $766,550 for a single-family home, but in some high-cost areas, it can be as high as $1,149,825. Because of their size, jumbo loans often have strict requirements for borrowers to meet. Each lender has certain requirements for jumbo loans, but if you’re thinking of applying for a jumbo loan to finance your home purchase, you’ll likely need a lower DTI ratio and a higher credit score.

Government-Backed Non-Conforming Loans

Government-backed loans also fall into the category of non-conforming. You can learn about each of them below.

FHA Loans

FHA loans are backed by the Federal Housing Administration, a government agency under the jurisdiction of the Department of Housing and Urban Development. These loans typically require a minimum of 3.5% down, a minimum credit score of 580 and a DTI ratio of no higher than 57%. However, these mortgage loans are considered on a case-by-case basis, so your lender may have some wiggle room in their requirements.

VA Loans

VA loans are available to eligible active-duty members of the U.S. armed forces including the National Guard and Reserves as well as veterans and surviving military spouses who meet certain requirements. Insured by the Department of Veterans Affairs, VA loans don’t require a down payment, but borrowers must pay a one-time funding fee, which can be rolled into the total loan amount. Individual lenders differ on the minimum credit score requirement for VA loans.

USDA Loans

USDA loans are insured by the U.S. Department of Agriculture (USDA) and can be used to purchase a home with no down payment in areas the USDA considers to be rural. To qualify for a USDA loan, you’ll usually need a minimum credit score of 640 and a household income that doesn’t exceed 115% of the median household income in the area where the eligible property is located. At this time, Rocket Mortgage^® doesn’t offer USDA loans.

Other Types Of Non-Conforming Loans

In addition to jumbo loans and government-backed loans are a few other types of non-conforming loans that may benefit you, depending on your situation. Keep in mind that our friends at Rocket Mortgage don’t offer the following types of mortgage loans.

• Interest-only mortgage: With an interest-only mortgage, the buyer only pays interest on the loan for a set number of years.
• Purchase-money mortgage: A purchase-money mortgage, also known as seller financing, is a loan that the seller of a property gives to a buyer.
• Hard money loan: This is a type of short-term loan from a person or private company that uses property or an asset as collateral if the borrower defaults.
• Holding mortgage: With this type of loan, the buyer makes payments to the seller. Once the loan is paid in full, the lender – in this case, the seller – hands over the title of the property to the buyer.

Non-Conforming Loans: Pros And Cons For Buyers

Still unsure if a non-conforming loan is the right type of mortgage option for you? Let’s break down the various benefits and drawbacks they offer home buyers.

Pros Of Non-Conforming Loans

Non-conforming loans are often popular among home buyers because, in some cases, they offer:

• Lower credit score requirements: Home buyers with a lower credit score or other negative marks in their credit history may quality for a non-conforming government loan.
• Smaller down payment requirements: Government-backed non-conforming loans have the option for no down payment or a low down payment, helping make it easier for buyers to achieve their dream of homeownership.
• Larger loan amounts: Non-conforming jumbo loans exceed the conforming loan limit for an area, making it possible to buy a more expensive property.
• More property types: Certain types of non-conforming loans allow you to buy property you couldn’t purchase with a conforming loan.

Cons Of Non-Conforming Loans

The cons of using a non-conforming loan to purchase a home include:

• Less standardization: Requirements vary from lender to lender with non-conforming loans, so there’s not a standard set of requirements that borrowers know they must meet.
• Less flexibility to shop around: Since non-conforming jumbo loans are offered by fewer lenders than conforming loans, you may not be able to shop around for the most favorable interest rate as much as you could with a conforming loan.

The Bottom Line: Non-Conforming Loans Can Open More Doors To Home Ownership

A non-conforming loan is any loan that doesn’t meet the funding requirements of Freddie Mac and Fannie Mae. In the case of non-conforming government loans, borrowers will typically have a lower down payment and less stringent credit requirements than they would with conforming loans. Numerous types of loans fall into the non-conforming category, each with different requirements. Still, non-conforming loans can make it possible for home buyers to secure a mortgage they wouldn’t qualify for if a conforming mortgage was their only option.

Want to see the mortgage loan options available to you? Get your initial approval with the Home Loan Experts at Rocket Mortgage® today.