What Is a Nonconforming Loan and How Does It Work?
Unpack nonconforming loans: learn why certain mortgages don't fit standard guidelines, how they function, and their various classifications.
Loans enable individuals to acquire significant assets like homes or vehicles. Lenders provide funds to borrowers, who repay over time, typically with interest. While many loans adhere to standardized criteria, nonconforming loans exist for situations outside typical lending guidelines. Understanding these loan types is important for borrowers.
Understanding Nonconforming Loans
A nonconforming loan is a mortgage that does not meet specific guidelines set by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. These GSEs purchase mortgages from lenders, providing capital for new loans. Mortgages meeting these criteria are conforming loans, readily bought and sold on the secondary mortgage market.
Selling conforming loans to Fannie Mae and Freddie Mac provides lenders with liquidity, allowing them to issue more mortgages. When a loan does not conform to these guidelines, lenders generally cannot sell it to these GSEs. The loan remains on the lender’s books, presenting higher risk and often resulting in different terms for the borrower.
Key Characteristics of Nonconforming Loans
Several factors can classify a loan as nonconforming, placing it outside standardized guidelines. One common reason is the loan amount. If a mortgage exceeds the maximum loan limits established by Fannie Mae and Freddie Mac for a given area, it becomes nonconforming. For instance, in 2025, the conforming loan limit for a single-family home in most areas is $806,500, reaching up to $1,209,750 in high-cost regions.
Another characteristic is the borrower’s financial profile. Conforming loans typically require a minimum credit score (often 620 or higher) and a specific debt-to-income (DTI) ratio. While an ideal DTI ratio is 36% or less, some conforming loans may allow up to 50% with other strong factors. If a borrower’s credit score is below these thresholds or their DTI ratio exceeds them, the loan may be classified as nonconforming.
Property type or use can also lead to a nonconforming designation. Loans for unusual, non-standard, or non-owner-occupied properties (e.g., certain investment properties or unique homes) often fall into this category. Additionally, if a borrower cannot provide the full documentation typically required for conforming loans (e.g., income verification through W-2s, pay stubs, and tax returns), the loan can be nonconforming.
Categories of Nonconforming Loans
Several distinct categories of nonconforming loans address varied borrower needs. One prominent type is the jumbo loan, designed for borrowers seeking financing that exceeds conforming loan limits set by Fannie Mae and Freddie Mac. These loans are used to purchase high-value properties in competitive real estate markets.
Subprime loans are another category, extended to borrowers with lower credit scores or credit challenges. Due to increased risk, they typically come with higher interest rates and different terms compared to conforming mortgages. While they provide an avenue to homeownership, the financial burden can be greater.
Alt-A loans are a third type, positioned between prime and subprime lending. Borrowers who qualify for Alt-A loans often have good credit but may have non-traditional income documentation (e.g., self-employment) or other factors preventing them from meeting standard conforming loan requirements. These loans offer flexibility for individuals whose financial situations do not fit conventional criteria.