The Facts: Conforming Vs. Non-Conforming

Not all loan officers write non-conforming loans. As a matter of fact, most do not - because they require a lot more work. By the same token, most real estate agents do not want to put the extra effort into a transaction if there are past credit problems. That is why it is better to have a pre-approval, before you go to a real estate agent.

We have had many people come to us after they had been told by other loan officers that it was impossible for them to consider buying a home. In most cases we were able to work with them successfully; by getting them the right loan and helping them find the right real estate agent and the right house at a price they could live with.

It is the job of the loan officer to decide whether your loan package will be a "conforming loan" or a "non-conforming loan".

The simple definition of a "conforming loan" is: A loan you can   get approved for at most any financial institution have good credit with no late payments on any accounts within 12 months, at least two years’ job stability at the same job, have a substantial down payment, money for closing costs, at least two months house payments extra after all costs, and your income to debt ratio is under 38%. Rates for these loans are very close to what you read in the newspaper.

The simple definition of a "non-conforming loan" is: You have a job and can make the payments. Your credit is used only to determine your interest rate and the loan amount to value of the home ratio. This ratio is referred to as your "LTV" or "Loan To Value".

There are many lenders who will lend to borrowers who are in foreclosure or who are currently in a bankruptcy. Borrowers who are in these situations have the worst possible credit. Lenders protect themselves by keeping the LTV low, about 65% to 70% of the appraised price of the property. By doing this, the lender is very well protected. If the borrower goes into foreclosure again with the new lender, the LTV is low enough that the lender can take the property back, sell it at a discount for a quick sale, and still pay off the debt.

 The lender rarely cares if there are other mortgages against the property, as long as the lender is in the first position. You see, when a lender takes a property back from a borrower the first lien position gets the proceeds of the sale first, then the second, then the third, etc. Rates for these types of loans are usually 1% to 6% higher that conforming rates.

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Lenders use three qualifying guidelines to determine what size mortgage you are eligible for. They are as follows:

1. Debt ratios:
Your monthly costs (including mortgage payments, property taxes, insurance) should total no more than 28% of your monthly gross (before-tax) income.

Your monthly housing costs plus other long-term debts should total no more than 36% of your monthly gross income.

Basically, lenders are saying that a household should spend not more than about one-fourth of its income (28%) on housing and not more than about one-third of its income (36%) on total indebtedness (housing plus other debts). Lenders feel that if they follow these guidelines, homeowners will be able to pay off their mortgages fairly comfortably and lenders will not have to worry about loan defaults and foreclosures.

2. Credit:
Any late payments must have good explanations and generally no more than one 30-day late payment is permitted within 12 months.

3. Funds to Close:
You must have the down payment, which must be your own funds, and the closing costs. In addition, you must have at least two month’s extra payments in the bank.

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1. DEBT RATIOS:
Every non-conforming lender has a different set of guidelines; therefore, this section should be used only as a general example. These types of lenders are saying that a household should spend not more than about one-half of its income (50%) on housing and not more than about two-thirds of its income (60%) on total indebtedness (housing and other debts). Lenders feel that if they follow these guidelines, homeowners will be able to pay off their mortgages fairly comfortably and lenders will not have to worry about loan defaults and foreclosures. These guidelines can be pushed with other compensating factors.  

2. Credit:
Used for calculating risk of loan (interest rate).

3. Funds to close:
Can come from many different sources; e.g., seller carry-back, gift letter, equity.

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In the past, banks and savings associations simply loaned their deposits to those needing funds. This soon become inefficient for two reasons: Savings deposits are considered short term liabilities, because a depositor can withdraw funds at any time. Mortgage loans are considered long-term assets, because the term of most mortgage loans is 25 to 30 years, with some exceptions. History has shown that the average mortgage is repaid within 7 to 9 years of its inception. This short-term versus long-term problem soon created a mismatch forcing some institutions to borrow additional capital to meet loan demand.

Simply borrowing more money became too expensive as interest rates increased, forcing lenders to seek alternatives. One solution was to sell the mortgage loans but retain the right to collect the monthly payments. A secondary mortgage market was created whereby certain investors purchased the loans, then entered into a servicing agreement allowing the institution that sold the loans to collect monthly payments, pay property taxes when due, and generally administer the loans. The investor simply accepts the monthly payments, minus whatever servicing fee is agreed upon. This fee is usually about three-eighths of one percent (.375%). This arrangement allowed lenders to originate, sell and service mortgage loans year around without having to match deposits with loan volume.

As investors started buying these loans it opened up the market for the non-conforming lenders. Investors who would like to see a higher rate of return on their money and would also accept a higher degree of risk started buying higher-risk loans. This kept climbing until the market opened up for the serious high-risk, high-rate investor who will buy any loan so long as it is secured by real property.

The secondary market from which lenders draw mortgage money is sometimes called the Capital Funds Market. It consists of a great variety of institutions: FNMA - Federal National Mortgage Association, also known as Fannie Mae; FHLMC - Federal Home Loan Mortgage Corporation, also known as Freddie Mac; GNMA - Government National Mortgage Association, also known as Ginny Mae (all quasi governmental agencies); as well as private financial institutions such as banks, life insurance companies, private investors, and thrift associations and, lately, Wall Street.

This market also considers alternative investments such as government bonds. Buyers of mortgages will often compare the yield they are offered with those of government securities. It is best to think of money as a commodity, like bread or potatoes. As such, it is subject to the forces of supply and demand, and the above example is one way the government manipulates the market and influences the money supply for housing.

First Financial Mortgage Corp. is a full service mortgage brokerage located in Overland Park, KS. We have a Department specializing in hard to process loans for those special situations. We shop over 25 major non-conforming lenders and have access to over 40 conventional lenders.

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