The term "non-conforming mortgage" can seem a little scary. What does it not conform to?
The short answer is the requirements of government agencies such as Fannie Mae or Freddie Mac. Loans purchased by these entities have to fit within certain limits of total loan amount, minimum down payment, type of property, and debt-to-income ratio. In many cases, once a lender has closed your mortgage, they will sell it to one of these entities who will then assume the risk. In short, a non-conforming loan is a loan that doesn’t meet bank criteria for funding. The reasons for that happening is because the loan amount is higher than the loan limit, not having a high enough credit score, or there just simply isn't enough collateral to back the loan.
Conforming loans are generally also considered lower risk. The vast majority of loans are conforming, as lenders prefer to be able to sell their loans. The guidelines also help lenders determine what is and is not high risk. They are easier to qualify for and generally have lower rates.
Why do I need a non-conforming loan?
- You are getting a "jumbo mortgage" of a total amount higher than the limit. The normal conforming loan limit is $453,100 as of 2018. Some states and localities have higher limits. For example, in Alaska, the limit is $679,650. If you are buying a high-end property you will have to get a jumbo loan, and will likely face stricter credit checks and may have to pay a higher down payment.
- You have a low credit score and cannot meet the requirements for a conforming loan, or already have a significant amount of debt, say from maxing out your credit cards. However, the chances of finding a loan in this case (credit score below 620) are very slim and if you do find one it is likely to be unfavorable. Not having a stable employment history and income level can also be a problem.
- You are buying a condo and the complex is considered non-warrantable. There are a number of things which can make the complex non-warrantable. They include
- A single entity owning more than 10% of the units.
- The majority of the units not being owner-occupied (this is often an issue for vacation condos as well as for complexes where there are both condos and rental units).
- More than 25% of the complex is commercial or office space.
- The HOA or the building management are involved in any kind of litigation.
- The complex is not completed. This is not uncommon with new developments, where sales may occur before the building is finished and handed over by the developer.
- The complex allows short-term rentals.
- More than 15% of the residents are in arrears with their association dues. This is considered a sign that the financial health of the complex as a whole is a problem.
- The complex is a non-traditional development not normally considered real estate, such as manufactured housing projects or houseboats.
For the vast majority of borrowers a conforming loan is not just the best option, but the one which is front and center. However, in high cost areas such as DC, jumbo mortgages are more common even with the raised limits on conforming loans. The area also has a lot of condo developments in which warrantability can be an issue. Be aware that banks will always consider a non-conforming loan to be high risk and undesirable. When choosing your new home you should take into account whether or not you can get a conforming mortgage and what your options are if you find yourself unable to do so.