Non-Conforming Loan

A non-conforming loan is a loan given to the borrower who does not pass the standard guidelines of loan issuance and has a high loan to value ratio, lower credit quality, or does not offer collateral. Such loans are risky as they do not meet the guidelines of government agencies. Hence, lenders cannot resell them to agencies like Fannie Mae or Freddie Mac. Due to the riskiness, the interest rate charged on this loan is higher. Therefore, it is advisable to use all traditional methods before applying for this loan.

• Non-conforming loans are provided to borrowers who do not meet the standard guidelines for loan issuance. These loans may have a high loan-to-value ratio, lower credit quality, or lack collateral. They are considered risky and cannot be resold to government agencies like Fannie Mae or Freddie Mac. 
• Due to the higher risk, non-conforming loans have higher interest rates. It is recommended to exhaust traditional loan options before considering these loans. 
• Non-conforming loans can be categorized into commercial non-conforming and residential non-conforming loans. 
• Non-conforming loans adhere to strict guidelines, making it challenging to structure and sell them to institutional investors or agencies. 

If a borrower requires a loan using the traditional method, he approaches lenders ready to give loans without being stringent on all the factors. However, the lenders are taking a risk as the loans are non-conforming, which means they cannot sell them to government agencies to free up their cash to issue further loans at the current rate. So, the lenders will be losing liquidity and taking risks. For this reason, they demand a higher interest rate from borrowers. Borrowers benefit as they get loans without meeting all the criteria.

1. Commercial Non-Conforming Loans: These are loans taken to fund commercial projects. Secured properties are kept as collateral, and loans are issued based on them.
2. Residential Non-Conforming Loans: The interest rate charged is much higher than normal, confirming residential loans. The activities in the market are mostly regulated, and the limit is set regarding the maximum loan that one can issue.

Mr. X is planning to buy a property worth $400,000. A general guideline is that the down payment must be 10% of the property value. So, 10% of $400,000 is supposed to be $40,000. Suppose Mr. X does not have $40,000. So, he will not traditionally get a loan. The mortgage rate in the traditional market is 4%, and for non-conforming loans, lenders charge 7%.

Even though Mr. X had the credit quality, he does not have the required down payment. Therefore, he may have to opt for a non-conforming loan.

• What is the best rate that the non-controlling lender is offering? Then, one should tally that rate with other lenders, choosing the lowest.
• Terms should be predefined. So, the borrower must check with the lender personally regarding the terms and document the terms before taking the loan. But, of course, one should accept the best conditions.
• One must choose a lender with experience, as the lender has been in the market for a long time to trust the rates and terms. New lenders are doubtful as the main motive could be confiscating the property.
• Before entering into the deal, one should read reviews from earlier borrowers regarding a lender. Past borrowers will share the real hand experience, which will help to portray a real picture.

Conforming loans are loans that meet the guidelines of government-sponsored entities. After a thorough analysis of the credit market, these entities have prepared a policy for loans that one could sell in the market. When a loan meets all the drafted guidelines, that loan is considered secured and is called a conforming loan. On the other hand, non-conforming loans follow strict guidelines and are difficult to resell to agencies for structuring and selling them to institutional investors.

• The down-payment requirement is less. So unlike conforming loans where the borrowers will have to abide by strict down-payment requirements, one can take non-conforming loans with less down-payment need.
• The approval process is short so one can take it quickly.
• Less creditworthy borrowers who plan to expand the business and face difficulty raising loans can otherwise opt for this method.

Non-conforming loans can be useful for borrowers who lack all the required factors to get loans approved by government agencies. So, this helps in the running of the credit market smoothly. Such loans are not defaults, but they are risky and should be given to creditworthy borrowers.

This article is a guide to Non-Conforming Loan and its definition. Here, we discuss its types and how it works, along with examples and benefits. You can learn more about it from the following finance articles: -

• Consumer Loan
• FHA Loan
• Loan Note
• Business Loan Calculator