Conforming vs Non-Conforming Loans

In recent years the options available to the borrower have multiplied greatly. These days a borrower can pick and choose from hundreds of different types of mortgages to suit their circumstances and one of the most interesting options to emerge has been the option of the non-conforming loan. In this article we’ll briefly explain the difference between conforming and non-conforming loans, and weigh up the pros and cons of both.

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First, what does conforming mean? In this case, it refers to a loan that adheres to strict lending guidelines laid out by the federal agencies Freddie Mac (Federal Home Loan Mortgage Corporation) and Fannie Mae (Federal National Mortgage Association).

Usually when we refer to conforming and non-conforming loans we are talking about the level of income documentation required from the borrower in order to approve the loan. A loan whose value is above a certain pre-set limit is also classed as non-conforming, but for the purposes of this article we’ll concentrate on the documentation angle.

A conforming loan typically requires the borrower to disclose full proof of income to the lender. If they can do this using pay stubs, W-2s or bank statements the lender will offer them a conforming loan with a comparatively low rate of interest.

If, however, the borrower is unable to produce adequate documentation perhaps because they are self-employed and therefore have no pay stubs, for instance they may only be offered a non-conforming loan. As the banks must accept a higher level of risk in lending to a borrower without a verified stream of income, they will usually demand a higher rate of interest to compensate for that risk.

Obviously, a conforming loan would be preferable for the average borrower, as lower interest rates could greatly reduce the total cost of the loan. However, for many people a non-conforming loan is preferable, especially if their circumstances prevent them from proving their income. Whether the hassle of proving income is worth the additional cost, though, is something we’ll leave up to you to decide.