Any time a phrase begins with the word "non," it tends to bring to mind negative connotations. In many respects, however, a non-conventional loan is a good thing, particularly if you’re a first-time homebuyer, if your credit is spotty, or if you just can't come up with a significant down payment.
A non-conventional loan is any loan that does not fit the rules and regulations of a traditional loan.
The fundamental difference between conventional loans and non-conventional loans is that with the latter, the Federal Housing Authority has your lender's back. If you default on your loan, the FHA steps in to pay the bank's claim. This insurance isn't free. It's included in your mortgage payment, and this can bump the payment up somewhat.
The fact that the FHA is willing to intercede to protect your lender from losing the money it has lent you gives your lender more latitude to approve your loan if you can't meet the more prohibitive requirements for a conventional loan. The Veteran's Administration also backs non-conventional loans.
Conventional loans typically require stellar credit scores. Without FHA insurance, your lender wants to be as certain as possible that you're going to pay the debt you're contracting for. Thanks to FHA insurance, lenders of non-conventional loans can take a chance on you if your credit history is less than perfect, or if you're young and don't have much of a credit record yet at all.
You might also get away with putting down less of a down payment with a non-conventional loan because the FHA is standing in the wings to protect your lender against default. You can put down as little as 3.5 percent on an FHA-insured loan, and the VA insures mortgages with no money down at all.
Non-conventional loans aren't entirely dreams come true for all homebuyers. They come with some limitations. For example, you typically can't borrow a huge sum on a home loan; you're limited to certain caps. If you find the perfect home listed at $300,000, a non-conventional loan may only cover $250,000 of the purchase price.
This doesn't necessarily mean you can't buy the property, but it can negate one of the advantages of a non-conventional mortgage. In order to buy the house, you would have to make up the difference between the FHA limit and the purchase price with a more significant down payment.
Although the FHA and VA make non-conventional mortgages available to more potential homebuyers, there's usually something in the transaction for the lenders as well. You'll typically pay more in interest on a non-conventional loan – sometimes a great deal more. A non-conventional loan helps you purchase a home when you otherwise would not be able to because you can't meet conventional loan requirements, but over the long haul, you'll typically pay more.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.