A nonconforming mortgage loan is any home loan that doesn't follow the standards set out by the two main GSEs -- government-sponsored entities -- that buy home loans: Fannie Mae and Freddie Mac. While the loan limit is a part of Fannie and Freddie's rules for a conforming mortgage, it isn't the only one. Loans can be nonconforming because of the type of property, the size of the loan or the qualifications of the borrower.
One of the most common types of nonconforming loan is the jumbo loan. As of 2013, conforming loans are capped at $417,000 or, in some high-cost areas, $625,000. Jumbo loans are any mortgage above that threshold. Government-sponsored entities are chartered to help middle-income families buy houses, so they typically don't buy very large mortgages. As such, these types of loans get made by lenders that either need to hold them in their portfolios or sell them without a guarantee on the secondary market. This is why jumbo loans are typically harder to qualify for and may carry higher rates or less favorable terms.
Borrower Income Issues
The GSEs like to see borrowers with stable, predictable income. However, some borrowers have income that swings due to commissions or other variances, while others are self-employed. In some cases, they won't meet the GSE's standards. These borrowers can turn to the nonconforming market. Nonconforming lenders charge higher rates and may impose harsher terms, but have the ability to dig more deeply to understand the borrower's specific situation and make the loan. In this same vein, some nonconforming lenders also lend to borrowers whose credit doesn't meet conforming standards, although the rate is higher.
Some properties can't qualify for a conforming loan, no matter how small the loan and how well qualified the buyer. Condominiums are particularly challenging, since the GSEs won't buy loans on condos that are largely held by the same party, have over 50 percent of their units being used as rentals, or are mixed-use properties with 20 percent or more commercial space. For these properties, a nonconforming loan is the only option.
FHA, VA Loans
Federal Housing Administration and Veteran's Administration loans exist in a gray zone. The terms of the programs allow borrowers who don't meet Fannie and Freddie's standards to get a home loan. On the other hand, they aren't technically nonconforming, either, since they're government-guaranteed mortgages. Regardless of their status, they can be an excellent alternative if you can't qualify for a traditional conforming loan. FHA and VA loans usually offer relaxed qualification terms, loan limits equal to or more generous than those of conforming loans and very competitive interest rates.
- Digital Vision./Digital Vision/Getty Images