by Tanya Davis
In the world of lending, there are two kinds of loans. These are "conventional" and "non-conventional" loans. If the loan is conventional, it is a mortgage loan other than those insured or guaranteed by a government agency such as the FHA (Federal Housing Administration), the VA (Veterans Administration), or the Rural Development Services. Within the framework of conventional loans there are two types, conforming and nonconforming. Conforming loans follow certain guidelines like those laid out by Fannie Mae and Freddie Mac, while the guidelines for underwriting nonconforming loans may differ from lender to lender. It is easy to confuse nonconventional with nonconforming; however in this article we will consider only nonconventional loans.
Loans for Private Purchases
Nonconventional loans are often used for purchasing private residences. For example, when the borrower needs to obtain a bridge loan (a loan that enables him to purchase a new home while the previous home is still on the market), he may turn to a nonconventional lender. Often borrowers have been rejected by conventional mortgage lenders. This may be because of one of many factors: • Poor credit • Employment history • Bankruptcy • Lack of income In cases like these, the borrower may turn to the non-conventional market. These loans are offered by traditional banks as well as private lenders. They encompass the sub-prime market, or “exotic” loans that have been the subject of much discussion since early 2007—those that go by names like flat minimum payment, option, “stress free” loans, and interest only loans. Fannie Mae and Freddie Mac are the two largest sources of non-conventional financing. These loans are slightly easier to obtain, but because they carry more risk on the part of the lender, they also have significantly higher interest rates.
Loans for Investors and Builders
Nonconventional loans are commonly used for real estate investing. This type of loan offers short-term financing for investors or builders who are in a hurry. For one reason or another, they are unable to wait for the lengthy process of bank loan approval. This could be because the property is "hot", they need to close the deal quickly, or they have a buyer or renter already lined up and waiting for the property to become available. Sometimes investors are interested in funding a project that a traditional bank would not normally finance. In this instance, they obtain their funding from private lenders. These are usually referred to as "portfolio loans." Portfolio lenders, unlike traditional lenders, almost never sell their loans to another party. A nonconventional lender does not have to follow the strict requirements that traditional lending institutions do. Because of this, a borrower seeks out at nonconventional lender may not have to:
- Get an appraisal, especially if the loan is below a certain threshold.
- Pay an application fee.
- Be required to pay a prepayment penalty.
- Have a credit check
Lenders offering nonconventional loans are willing to take on more risk. They will, however, still require that a borrower's purchase or construction makes sense, and that the borrower has the collateral to back the loan. This may mean sharing your business plan (in the case of an investor or builder), or submitting a listing of assets for the lender’s consideration.
Tanya Davis is a freelance writer living in Tennesee.
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