What is Non-conforming Mortgage?

1151 reads · Last updated: December 5, 2024

A non-conforming mortgage is a mortgage that does not meet the guidelines of government-sponsored enterprises (GSE) such as Fannie Mae and Freddie Mac and, therefore, cannot be sold to them. GSE guidelines include a maximum loan amount, suitable properties, down payment requirements, and credit requirements, among other factors.A non-conforming mortgage may be contrasted with a conforming mortgage.

Definition

A non-conforming mortgage is a type of loan that does not meet the guidelines set by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac, and therefore cannot be sold to these entities. The GSE guidelines include factors such as maximum loan amount, suitable property types, down payment requirements, and credit requirements.

Origin

The concept of non-conforming mortgages originated from the development of the U.S. housing market. With the establishment of Fannie Mae and Freddie Mac in the mid-20th century, these entities set strict loan standards to ensure the safety and liquidity of loans. However, a significant number of loans did not meet these standards, leading to the emergence of non-conforming mortgages.

Categories and Features

Non-conforming mortgages are primarily divided into two categories: subprime loans and non-qualifying loans. Subprime loans are typically due to lower credit scores or unstable income of the borrower, while non-qualifying loans may exceed the GSE's loan limits or involve property types that do not meet the requirements. These loans usually have higher interest rates due to increased risk.

Case Studies

During the 2008 financial crisis, non-conforming mortgages played a significant role in the U.S. housing market. Many financial institutions, such as Lehman Brothers, suffered heavily due to holding large amounts of these loans. Another example is Countrywide Financial, which was acquired by Bank of America after issuing a substantial number of non-conforming loans.

Common Issues

Common issues investors face with non-conforming mortgages include high default risk and lack of liquidity. Additionally, there is a misconception that these loans are always detrimental, whereas they can actually provide flexible financing options for certain borrowers.

Suggested for You

Look-Alike Contracts

Look-alike contracts are a cash-settled financial product based on the settlement price of a similar exchange-traded, physically settled futures contract. Look-alike contracts are traded over the counter and they carry no risk of actual physical delivery regardless of the terms of the underlying futures contract.Futures look-alike contracts are regulated by the Commodity Futures Trading Commission (CFTC).

Opening Cross

The opening cross is a method the Nasdaq uses to determine the opening price for an individual share of the stocks that trade on its exchange. This method accumulates data on the buy and sell interest among market participants for a particular security two minutes before the market opens. The Nasdaq makes this information available to all investors.According to Nasdaq, the opening and closing cross processes give all investors access to the same information, and ensures their orders get the same treatment. This brings fairness and transparency into the marketplace. It also efficiently matches buyers and sellers to ensure market liquidity (that is, the ability for investors to find ready purchasers if they need to sell their positions quickly).

Open Market

An open market is an economic system with little to no barriers to free-market activity. An open market is characterized by the absence of tariffs, taxes, licensing requirements, subsidies, unionization, and any other regulations or practices that interfere with free-market activity. Open markets may have competitive barriers to entry, but never any regulatory barriers to entry.

Mean Reversion

The concept of mean reversion is widely used in various financial time series data, including price, earnings and book value. When an asset's current market price is less than its average past price, it's considered attractive for purchase. Conversely, if the current price is above the average, it's expected to fall. Traders and investors use mean reversion for timing of their respective trading and investment strategies.

Distressed Sales

A distress sale—also called a distressed sale—occurs when a property, stock, or other asset must be sold quickly. Distress sales often result in a financial loss for the seller who, for reasons of economic duress, must accept a lower price. The proceeds from these assets are most often used to pay debts or medical expenses or for other emergencies.

Absolute Advantage

Absolute advantage is the ability of an individual, company, region, or country to produce a greater quantity of a good or service with the same quantity of inputs per unit of time, or to produce the same quantity of a good or service per unit of time using a lesser quantity of inputs, than its competitors.Absolute advantage can be accomplished by creating the good or service at a lower absolute cost per unit using a smaller number of inputs, or by a more efficient process.