Nonconforming Mortgage Definition

What Is a Nonconforming Mortgage?

A nonconforming mortgage is a home loan that does not comply with the Federal Housing Finance Agency’s (FHFA) amount limits. Fannie Mae and Freddie Mac do not back this loan type due to its size.

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What Is a Nonconforming Mortgage?

A nonconforming loan (also called nonconforming loan, jumbo mortgage, or jumbo loan) does not meet the standards set by the Federal Housing Finance Agency, particularly the loan limit amount.

In turn, because the FHFA sets the rules on which loans Fannie Mae and Freddie Mac can back, a nonconforming mortgage is not supported by these two entities.

However, a nonconforming mortgage is useful when a buyer needs to finance a more expensive property than the average in its location.

nonconforming mortgage house

Taking out a traditional home loan is usually insufficient to cover the purchase price of such property. A nonconforming mortgage serves as a viable alternative due to its size (hence the name).

Nonconforming mortgages offer two indisputable advantages:

  1. Being able to borrow a substantial sum of money to close a high-end home purchase without taking out multiple loans or a piggyback mortgage[1].
  2. Enjoying flexible loan terms.
What Is the Cutoff Amount for a Jumbo Loan?

The maximum amount for a jumbo loan varies from lender to lender. In theory, a borrower with excellent credentials may borrow up to $3 million, supposing they can find a lender who will agree to those terms.

That said, even with a jumbo mortgage, a luxury house in the most upscale neighborhoods in the United States is still out of reach for the average person[2]. However, it can render most of the nicest properties in a community affordable.

What Are the Advantages of a Nonconforming Mortgage?

Many homeowners, especially during the pre-housing crisis years, prefer to take out a second mortgage to get around the private mortgage insurance[3] and snag a lower interest rate on the first mortgage.

However, a nonconforming mortgage can eliminate the need for a piggyback mortgage, which is generally viewed as a bad decision post-Great Recession[4]. Many homeowners even had trouble seeking loan modification[5] because they had piggyback mortgages.

nonconforming mortgage piggyback

By contrast, a nonconfoming mortgage can finance a large house purchase the way two smaller home loans can. Since just one home loan is involved, the borrower only has to deal with one monthly mortgage payment. And since no other mortgage sits behind the primary mortgage, its terms are easier to modify if needed.

Moreover, jumbo mortgage rates can be fixed or adjustable, and can be interest-only[6] too. Plus, they are available in various terms, which means the borrower can spread out the payment over up to 360 months.

What Are the Disadvantages of a Nonconforming Mortgage?

Nonconforming mortgages are oversized home loans. Their inherent size presents a risk to the borrower and to the lender, which means there are many downsides to them.

Below are the drawbacks to a nonconforming mortgage:

  • Higher interest. Nonconforming mortgage rates are higher than those of conforming ones because they cannot be sold to Fannie Mae and Freddie Mac. Although private investors can buy these home loans, lenders usually wind up keeping them on their books due to strict regulations. As a result, any nonconforming mortgage lender wants more money to offset the greater risk.
  • Larger down payment. Lenders of nonconforming mortgages usually demand borrowers to put down no less than 20% (although this is negotiable, in some cases). Paying one-fifth of a high-end property’s cost out of pocket means tying up more of the borrower’s cash in an illiquid asset[7], which acts as the lender’s safety net.

nonconforming mortgage jumbo loan

  • Costlier closing costs. Considering that nonconforming loan programs have strict criteria, one has to expect to pay more costs and fees at closing. One of the additional steps that make the application process more expensive is the extra appraisal[8]. This requirement helps ensure that home values are great enough to justify the high level of borrowing.
  • Harder approval process. Jumbo mortgage lenders want borrowers with high credit scores and decent cash reserves. In general, nonconforming mortgage lenders also look for extensive documentation and most of them have a hard cap of 43% debt-to-income ratio[9].
Are Non-Conforming Loans More Expensive?

Nonconforming loans are likely to be more expensive monthly than conforming loans for many reasons.

First, a high interest rate can significantly drive up the monthly jumbo mortgage payment, even if a borrower puts down at least 20%. Considering how a fully amortized mortgage is paid off over time[10], it would take many years before the principal balance noticeably goes down. This happens because most of the early payments go toward the interest.

This inability to reduce the mortgage’s principal balance more quickly means building home equity[11] at a much slower pace. Owning 20% of the property after a large down payment can give one a head start, which can keep the home loan from going upside down[12].

Second, costlier closing costs mean more out-of-pocket expenses. Typically, these costs and fees are equivalent to 2% to 6% of the loan amount[13]. However, since the nonconforming mortgage is oversized, the total closing costs are enormous.

Is a Nonconforming Mortgage a Bad Idea?

It is not a bad idea if a borrower can afford it. Unqualified applicants are unlikely to get approved anyway because nonconforming mortgage lenders are extra stringent.

Perhaps the greatest harm a nonconforming loan can do to an unqualified applicant is to hurt their credit score due to hard inquiries[14]. However, the negative impact of a jumbo mortgage rejection ends there since credit denials do not show up on credit reports[15].

What Credit Score Is Needed for a Nonconforming Mortgage?

Borrowers do not need a very good or exceptional FICO score[16] to take out a nonconforming home loan. However, even a good credit score may be inadequate to satisfy lenders.

Generally speaking, nonconforming home loan providers require borrowers to have a score of more than 700. Sometimes, an applicant may even need a score of 720 to qualify.

According to FICO 8 and 9 scoring models[17], good credit ranges from 670 to 739 scores. Therefore, not all borrowers with good credit can make the cut.

BY THE NUMBERS: About six in 10 Americans have a FICO score of 700 or higher.

Source: MarketWatch

Takeaways

  • Nonconforming mortgages (also known as jumbo loans) are home loans that go over the federal government’s loan limits. Because they do not comply with these loan standards, they are not backed by Fannie Mae and Freddie Mac.
  • While nonconforming mortgages provide borrowers the necessary funds to buy high-end properties, they are expensive due to higher interest, higher down payment, and other associated fees.
  • Because of the risk inherent in an oversized loan, lenders employ the strictest qualification standards for nonconforming loan applicants.

Sources

  1. Kilroy, A. (2021.) What is a piggyback mortgage loan & how does it work? MSN. Retrieved from https://www.msn.com/en-us/money/realestate/what-is-a-piggyback-mortgage-loan-how-does-it-work/ar-AAQs07w
  2. Friedman, R. (2021.) Buying a Luxury Home? It’ll Cost You More Than That Million-Dollar Price Tag. Mansion Global. Retrieved from https://www.mansionglobal.com/articles/buying-a-luxury-home-it-ll-cost-you-more-than-that-million-dollar-price-tag-146633
  3. Marquand, B. (2020.) How to Avoid PMI When Buying a Home. NerdWallet. Retrieved from https://www.nerdwallet.com/article/mortgages/how-to-avoid-pmi
  4. Beard, J., Jones, R., & Langston, V. (2010.) The Blame Game – Who’s at Fault in the Mortgage Crisis? Shippensburg University. Retrieved from https://www.ship.edu/contentassets/569211b0c6f243808c3c64f54e816cd2/v2jonesp29-p43.pdf
  5. Consumer Financial Protection Bureau. (2017.) What is a mortgage loan modification? Retrieved from https://www.consumerfinance.gov/ask-cfpb/what-is-a-mortgage-loan-modification-en-269/
  6. Bowling, L. (2021.) What Are Interest-Only Mortgages And How Do They Work? Rocket Mortgage®. Retrieved from https://www.rocketmortgage.com/learn/interest-only-mortgage
  7. Reed, E. (2020.) What Types of Assets Are Illiquid? SmartAsset. Retrieved from https://smartasset.com/investing/illiquid-assets
  8. Backman, M. (2021.) What Is a Home Appraisal? Millionacres. Retrieved from https://www.millionacres.com/real-estate-investing/rental-properties/what-home-appraisal/
  9. Van Heest, N. (2018.) Financing your forever home: 3 keys to jumbo loans. Guaranteed Rate. Retrieved from https://www.rate.com/resources/financing-your-forever-home-3-keys-to-jumbo-loans
  10. The Truth About Mortgage. (2021.) Mortgage Amortization: Learn How Your Mortgage Is Paid Off Over Time. Retrieved from https://www.thetruthaboutmortgage.com/amortization/
  11. Porter, K. (2021.) How to build equity in your home. Bankrate. Retrieved from https://www.bankrate.com/home-equity/how-to-build-equity-in-your-home/
  12. Christensen, T. (n.d.) What is an “Upside Down” Mortgage? SmartCapitalMind. Retrieved from https://www.smartcapitalmind.com/what-is-an-upside-down-mortgage.htm
  13. Ceizyk, D. (2020.) Closing Costs that Are (and Aren’t) Tax-Deductible. LendingTree. Retrieved from https://www.lendingtree.com/home/mortgage/are-closing-costs-tax-deductible/
  14. Equifax. (2018.) Understanding Hard Inquiries on Your Credit Report. Retrieved from https://www.equifax.com/personal/education/credit/report/understanding-hard-inquiries-on-your-credit-report/
  15. Ulzheimer, J. (2020.) Does a Declined Loan Appear on Your Credit Report? Experian. Retrieved from https://www.experian.com/blogs/ask-experian/does-a-declined-loan-appear-on-your-credit-report/
  16. DeNicola, L. (2021.) Your guide to credit score ranges. Credit Karma. Retrieved from https://www.creditkarma.com/advice/i/credit-score-ranges
  17. Priority Tradelines. (2017.) How FICO Score 9 Is Different From FICO Score 8 To Boost Credit Rating. Retrieved from https://prioritytradelines.com/blog/fico-9-vs-fico-8

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