Nonconforming Loans: What Are They and How Do They Work?

If you’re exploring options for buying or refinancing a home, you might be worried about the minimum credit requirements associated with certain loans.

Thankfully, when it comes to buying or refinancing a home with less-than-stellar credit, nonconforming loans can be a great solution.

Nonconforming loans often get a bad rap, likely because their name implies breaking some sort of rule. For many people, nonconforming loans are one of the best (if not one of the only) choices for financing a home purchase, mainly because they have less strict qualification requirements than conforming loans.

We’ll explain what a nonconforming loan is, how nonconforming loans are different than conforming loans and what it all means for you as you weigh your options for purchasing or refinancing a property.

Nonconforming Mortgages, Explained

A nonconforming loan is a loan that does not meet the requirements of government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. The role of Fannie Mae and Freddie Mac is to buy and guarantee conforming mortgages – or mortgages that meet their guidelines – to allow for money to be available for mortgages for millions of Americans.

There’s nothing inherently bad about nonconforming loans – they’re just loans the GSEs won’t buy because the loans have different, often less strict, requirements for borrowers. However, nonconforming loans can be riskier for investors, so they are often more expensive for borrowers than conforming loans.

Nonconforming loans are very common when purchasing more expensive homes since loans exceeding $726,200 are nonconforming jumbo loans.^[1]

Nonconforming loans may also be a good idea for buyers who:

• Have had a bankruptcy
• Have negative marks on their credit
• Want to put a smaller amount toward a down payment
• Want to buy a property that’s ineligible for a conforming loan.

Nonconforming Loans vs. Conforming Loans

The difference between conforming and nonconforming loans can be summarized by the types of properties financed, size limits of the loan and the borrower’s qualifications. Let’s look at how the requirements for conforming loans compare to the qualifications for nonconforming mortgages.

	Conforming Loans	Nonconforming Loans
Minimum Credit Score Needed	620[2]	No official minimum, but often 580
2023 Maximum Loan Amount (for single-family homes)	$726,200 for most of the United States, but certain higher-cost areas have a maximum up to $1,089,300[3]	Maximum loan amount varies by lender
Minimum Down Payment	As low as 3%, but you’ll have to pay private mortgage insurance if you put down less than 20%[2]	0% with some programs, like a Department of Veterans Affairs (VA) loan or U.S. Department of Agriculture (USDA) loan
Debt-to-Income (DTI) Ratio	36% preferred, with a maximum allowable DTI ratio of 50%[4]	No official limit

18.05%

The 2023 increase in conforming loan limits helps home buyers keep up with rising home prices.^[8]

Examples of Nonconforming Loans

Nonconforming loans are fairly common and can even be backed by government departments like the VA and USDA. Let’s look at some examples of nonconforming loans, the qualification criteria and how they work.

VA loans

VA loans are loans issued to individuals who serve in or were honorably discharged from the U.S. military. These loans are backed by the Department of Veterans Affairs.

VA loans offer the option to purchase a home with a 0% down payment, but only if you meet certain qualifying standards. Most lenders who issue VA loans look for a minimum credit score of 580,^[5] and you’ll have to verify your income to prove you can make payments.

FHA loans

Federal Housing Administration (FHA) loans are loans insured by the FHA. They are designed to help make homeownership more accessible, especially for first-time home buyers.

With FHA loans, buyers with a credit score of at least 580 can put as little as 3.5% down. For buyers with credit scores between 500 and 579, the down payment minimum is 10%.^[6] FHA loans with a loan-to-value that exceeds 80% (as in a down payment of less than 20%) require the borrower to pay mortgage insurance premiums (MIPs).^[6]

Another qualification for borrowers seeking FHA loans is a debt-to-income ratio below 43%.^[6] As with other loans, you’ll have to provide proof of employment and income.

Keep in mind that FHA loans are usually only available for primary residences.

USDA loans

USDA loans allow you to finance the purchase of property in rural areas with loans backed by the U.S. Department of Agriculture. Only properties located in eligible rural areas can be financed with USDA loans.

With a USDA loan, you have the option of a 0% down payment, but you can only qualify for this type of nonconforming loan with a household income that does not exceed 115% of the median household income in the area where the home is located.

USDA loans are only available if you cannot finance the purchase using a conventional mortgage (without private mortgage insurance). Finally, USDA loans require you to have a DTI ratio of 41% or less.^[7]

Jumbo loans

Jumbo loans are nonconforming loans that exceed the conforming loan limit set by the Federal Housing Finance Agency (FHFA). For 2023, the conforming loan limit is $726,200, with certain higher-cost areas offering increased limits up to $1,089,300.^[8]

A jumbo loan is used to finance any amount above the conforming loan threshold, serving the same role as a conventional mortgage, only without the backing of Fannie Mae and Freddie Mac. Since jumbo loans aren’t backed by any government entity, they may have higher interest rates, though the exact rates are set by each lender.

Jumbo loans don’t have exact qualification requirements, but you can expect most lenders to look for a DTI ratio of 45% or less, a credit score of at least 680 and proof of income.

Holding mortgage

A holding mortgage is a type of seller financing where the seller of the home retains the title until the buyer pays off the debt. Holding mortgages are offered by individual sellers, so there aren’t specific qualifications – the seller and buyer negotiate and agree on the rate, terms, payment length and down payment.

Interest-only mortgage

An interest-only mortgage is a type of mortgage where you make interest-only payments for a specified period of time, after which your monthly payment will include interest and principal. Interest-only mortgages usually require a sizeable down payment, high credit scores and a low DTI ratio. The benefits of interest-only mortgages include lower payments in the early years of the loan, more flexible payment options and no loan size limit.

Purchase money mortgage

A purchase money mortgage is a loan financed by the seller of the property. Purchase money mortgages can be useful if you don’t qualify for a conventional or government-backed mortgage. Purchase money mortgages have flexible qualification requirements that are determined by the individual seller of the property.

Hard money loan

Hard money loans are short-term loans issued by private lenders and secured by the asset it’s being used to purchase (typically real estate). These types of loans are popular with investors who need a quick closing or want to buy a property.

Hard money lenders usually don’t have specific requirements for credit and DTI ratios but will almost always ask for a down payment of 20% or more. In addition, hard money lenders want to make sure the property used as collateral is a valuable asset.

Interest rates on hard money loans can vary and are typically significantly higher than rates offered with traditional mortgages.

Pros and Cons of Nonconforming Loans

Nonconforming loans are neither good nor bad, but they still come with their own unique pros and cons.

Benefits of nonconforming loans

Some of the benefits of nonconforming loans include:

• Can be used to finance a more expensive home via jumbo loans
• Ability to buy different types of properties (land, farms and ranches, boarding houses and more)
• Lower down payment requirements
• Lower credit requirements
• Less strict DTI ratio requirements

Drawbacks of nonconforming loans

Nonconforming loans can be an excellent alternative to conventional mortgages, though you should be aware of the drawbacks, which may include:

• Higher interest rates (this is not always true – sometimes they have lower rates)
• Fewer lenders to choose from
• More stringent requirements (in the case of jumbo loans)
• Fewer consumer protections

Not Your Everyday Mortgage

The GSEs might use a certain set of guidelines to determine if they’ll buy a mortgage, but that doesn’t mean loans that don’t adhere to those guidelines are not as good. Nonconforming loans offer a less traditional, more customized way to buy a home. Nonconforming loans aren’t your everyday mortgage, even though they present a perfectly viable option for financing your home purchase.