Conforming vs. Non-Conforming Loans
Just like many other fields, the real estate community makes use of its own lingo and acronyms. So, is there any good reason to learn some of the lingo attached to real estate? Certainly a good idea if you’re interested in owning some. A good example is the vague terms “conforming” and “nonconforming” loans. Because of their ignorance of these definitions, many people assume (because of their less-than-stellar credit history, self employment or high debt ratios) they won’t qualify for a mortgage thanks to conventional wisdom. But knowledge is power – and in this case, the tool that will put you into your very own four walls.
Who decides what’s conforming and what’s non-conforming? Fannie Mae and Freddie Mac, of course. No, these aren’t your mom’s country cousins or some despotic real estate tyrants, they’re the two stockholder-owned corporations that purchase mortgage loans from lending institutions. They then package the mortgages into securities and sell the securities to investors. By doing so, Fannie Mae and Freddie Mac provide a continuous flow of affordable funds for home financing that results in the availability of mortgage credit for Americans. Fannie Mae and Freddie Mac guidelines also establish the maximum loan amount, borrower credit and income requirements, down payment, and suitable properties.
Let's start with non-conforming loans, also known as jumbos. While it might have a negative ring to it, a non-conforming loan can be the ticket to homeownership for many with unusual circumstances. The terms are actually quite descriptive: non-conforming mortgage loans are for borrowers whose situations do not “conform” to strict Fannie Mae/Freddie Mac underwriting guidelines.
The good news is that credit specifications are more lenient than any other type of financing. In other words, non-conforming loans are much easier to qualify for than conforming loans. They also close faster, have reduced or no reserve requirements, allow expanded use of loan proceeds and provide higher levels of cash out for debt consolidation.
And there’s more good news. There is no stigma attached to this type of financing, and it’s not even designed to be a permanent financing situation. Non-conforming loan programs can actually help you improve your credit. By having a mortgage of any kind, and keeping up current payments and cleaning up the rest of your credit, in two or three years you may qualify for conforming financing, even if you’ve had a foreclosure or bankruptcy. Why should you be interested in switching to conforming financing? Because the interest rates are lower, of course.
Not long ago, borrowers or properties that did not meet conforming guidelines found it extremely difficult, if not impossible, to obtain mortgage financing. Financing for non-conforming loans was usually subject to high interest rates and lenders frequently asked for larger down payments. Since lenders felt that non-conforming loans were riskier than conforming loans, they required a higher return on their funds. Recently, this traditional way of making mortgage loans has undergone changes in some lending circles. By combining the elements of a reasonable down payment and slightly higher rates, some lenders are finding it more attractive to offer non-conforming loans.
To explain non-conforming financing a bit further, there are two different situations which necessitate a non-conforming loan.
1. Non-conforming borrowers. This is the most common category. As we’ve discussed, these are people whose credit isn’t perfect. This can include temporary setbacks (loss of job, extended disability, etc.) If there are only a few dings on your credit report but your overall financial situation is fairly sound, then lenders will be willing to take the extra risk (and therefore charge the extra interest) that non-conforming loans pose.
2. Non-conforming properties. These are houses that don’t meet the standards for conforming loans. This does not necessarily mean there’s anything wrong with the home (although it can mean that). It may, for instance, have an unusual mechanical system (such as solar or wind-powered heat) or unique structural qualities.
There are many circumstances which might otherwise prevent your from conforming financing, and they include: self employment; complicated tax returns; if you do not wish to disclose or document your income; high debt ratios; current or previous credit difficulties; if you want to repay federal tax liens; and if you want to recoup equity from your homestead.
What if you don’t have any of the above circumstances? Then you’ll most likely qualify for a conforming loan. The most important difference between conforming and non-conforming loans, however, is loan limits. Fannie Mae and Freddie Mac will purchase loans only up to a certain loan limit that changes each year. Properties with five or more units are considered commercial properties and are handled under different rules.
The 2017 conforming loan limits in this area are $598,000 for a one-family residence; $765,550 for a two-family residence; $925,350 for a three-family residence; and $1,150,000 for a four-family residence.
There are numerous loan products available to consumers designed to assist in home ownership. It is wise to explore your options to see if you can comfortably qualify for a financing. A good loan officer will take into consideration your unique financial circumstances and will make suggestions about the best loan solutions for your needs. Be sure to communicate accurately with your lender so they can advise you properly.
As an active real estate agent, I have worked with many superb lenders over the years. As in most things, I believe it is critical to align yourself with someone who knows the industry, provides you with accurate information, and is willing to work hard for you.