Nonconforming Mortgage

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What is a non-conforming mortgage

A non-conforming mortgage does not meet the guidelines of government sponsored companies (GSE) such as Fannie Mae and Freddie Mac. Therefore, it cannot be sold to Fannie Mae or Freddie Mac. The GSE guidelines include a maximum loan amount, suitable properties, down payment requirements and credit requirements, among other factors.

DISTRIBUTION OF A NON-CONFORMING MORTGAGE

Non-conforming mortgages are not bad loans in the sense that they are risky. However, financial institutions do not like them because they are more difficult to sell. For this reason, banks will usually charge a higher interest rate.

Although private banks initially take out most mortgages, they often end up in the portfolios of Fannie Mae and Freddie Mac. These two state-sponsored companies (GSE) buy loans from banks, then condition them in mortgage-backed securities (MBS) that sell on the secondary market. An MBS is a type of asset-backed guarantee guaranteed by a collection of mortgages from a regulated and authorized financial institution. Although there are private financial companies that will buy, package and resell an MBS, Fannie and Freddie are the two biggest buyers.

Banks use money from the sale of mortgages to invest in offering new loans at the current interest rate. But Fannie Mae and Freddie Mac can’t buy just any mortgage product. Both GSEs have federal rules limiting the purchase of loans that are considered relatively risk-free. These loans are conforming mortgages, and the banks love them precisely because they will sell easily.

In contrast, mortgages that Fannie Mae and Freddie Mac cannot buy are inherently riskier for banks to take out. These unsaleable loans must either remain in the bank’s portfolio or be sold to entities specialized in the secondary market for non-conforming loans.

Types of non-conforming mortgages

There are various borrower situations and types of loans that Fannie and Freddie find non-compliant.

  • The most common non-conforming mortgage is what is often called a jumbo mortgage. Jumbo mortgages are loans taken out for more than the Fannie Mae and Freddie Mac limits. In 2020, this limit in most U.S. counties was $ 453,100, but in some high-cost areas it can reach $ 679,650.
  • But mortgages don’t have to be jumbo to be non-compliant. A small deposit can trigger a non-compliant status. The threshold varies but could be 10% on a conventional mortgage or as little as 3% on an FHA loan.
  • In addition, one factor is the buyer’s debt-to-income ratio (DTI), which must generally be less than 42% to be considered a compliant loan. A credit score above 630-650 is also generally required.
  • The type of property can also determine if a mortgage is non-compliant. For example, condo buyers often get tripped when they learn that the vacation unit of their dreams is non-compliant because the complex is considered unsecured. This includes co-ownership associations where a single entity, such as the developer, owns more than 10% of the units. Other pitfalls include if the majority of the dwellings are not owner-occupied, if more than 25% of the area is commercial or if the owners association (HOA) is in dispute.

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