Navigating the world of mortgages can be complex, especially if you don’t fit the typical borrower profile. If you’re self-employed, a gig worker, or have unique financial circumstances, a traditional mortgage might be difficult to obtain. This is where non-QM loans come in. This guide provides a detailed overview of non-QM loans, helping you understand their features, benefits, drawbacks, and whether they’re the right choice for your homeownership journey.
What are Non-QM Loans?
Non-Qualified Mortgages (Non-QM loans) are mortgage loans that don’t meet the strict standards set by the Consumer Financial Protection Bureau (CFPB) for Qualified Mortgages (QM). These standards dictate specific loan features and require lenders to adhere to strict criteria when evaluating a borrower’s financial situation and ability to repay the loan. Common examples of non-QM loans include asset-based loans and no-income verification loans.
Non-QM lenders often employ manual underwriting, granting them greater flexibility in their lending guidelines. This allows them to work with borrowers who might be considered too risky by conventional lenders due to factors such as non-salaried income or lower credit scores. These loans are characterized by:
- Alternative Income Verification: Instead of relying solely on W-2 forms and pay stubs, non-QM lenders may accept bank statements, investment account statements, 1099s, rental income receipts, and other business receivables as proof of income.
- Flexible Debt-to-Income Ratios: While the CFPB limits the DTI ratio for QM loans to a maximum of 43%, non-QM loans may allow for higher DTI ratios, often up to 50% of the borrower’s total monthly income.
- Lenient Credit Requirements: In some cases, non-QM loans may not require a waiting period after bankruptcy or foreclosure, allowing borrowers to secure a mortgage sooner after these events.
Non-QM vs. Qualified Mortgages: Key Differences
The flexibility of non-QM loans comes with potential risks for both the lender and the borrower. Non-QM loans may include features prohibited by the CFPB for qualified mortgages, such as:
- Loan terms exceeding 30 years
- Interest-only payments
- Balloon payments
- Negative amortization
Furthermore, QM loans are subject to the CFPB’s cap on upfront mortgage points and fees, which cannot exceed 3% of the loan amount for loans over $100,000. Non-QM lenders may charge higher points and fees.
A significant difference is that non-QM lenders are not obligated to follow the CFPB’s “ability-to-repay” rule, which mandates evaluating eight key aspects of a borrower’s finances:
- Current income/assets
- Current employment status
- Monthly payment for the mortgage loan
- Monthly payment on any simultaneous loans secured by the home
- Monthly payment for mortgage-related obligations
- Current debt obligations, alimony, and child support
- Monthly debt-to-income ratio or residual income
- Credit history
The less stringent standards of non-QM loans may increase the risk of borrowers obtaining loans they cannot truly afford.
Who Can Benefit from Non-QM Loans?
While QM standards are designed to protect consumers, they can exclude individuals with non-traditional financial profiles. Non-QM loans can be particularly beneficial for:
- Self-Employed Borrowers: With fluctuating income streams and diverse income sources, self-employed individuals often find it challenging to qualify for a QM loan. Bank statement loans, a common type of non-QM loan, are based on cash flow and liquid assets rather than W-2s.
- Real Estate Investors: Investors who fix-and-flip properties or generate rental income often require quick funding. DSCR (Debt Service Coverage Ratio) loans and asset depletion home loans can accommodate these borrowers.
- Foreign Nationals: Non-resident borrowers with limited or no U.S. credit history may struggle to qualify for traditional loans. Non-QM lenders use international credit reports and other documentation to assess their creditworthiness.
- Prime Borrowers Seeking Specific Loan Features: Borrowers with excellent credit may opt for non-QM loans to access features like interest-only payments or higher DTI limits.
- Near or Non-Prime Borrowers: Individuals with insufficient credit or a recent bankruptcy or foreclosure may find non-QM loans more accessible, although they typically require larger down payments and stricter standards.
- Borrowers with Significant Assets: Asset qualifier loans are ideal for borrowers with substantial assets and good credit. They may choose to finance the purchase to keep their assets invested elsewhere.
The Drawbacks of Non-QM Loans
While offering flexibility, non-QM loans come with notable drawbacks. They typically involve higher fees, higher down payment requirements, and elevated interest rates.
The higher interest rates and stricter terms compensate the lender for the increased risk they undertake, as Fannie Mae and Freddie Mac cannot purchase non-QM loans. These features are considered risky by the CFPB as they could lead to delinquency and default.
Non-QM vs. Non-Conforming Loans
It’s essential to distinguish between non-QM loans and non-conforming loans. While both fall outside the typical mortgage norms, they deviate in different ways. Non-QM loans deviate from the CFPB’s standards, while non-conforming loans don’t meet the standards set by the Federal Housing Finance Agency (FHFA), often because they exceed conforming loan limits.
However, non-conforming loans are considered a subcategory of non-QM loans, and there is some overlap between the standards set by the FHFA and CFPB.
Where to Find Non-QM Loans
If you’re considering a non-QM loan, start by assessing your eligibility. Generally, you’ll need a minimum credit score of 620, stable income, and a consistent employment history.
Many mortgage brokers work with non-QM wholesale lenders and can be a valuable resource.
When you find a lender, inquire whether they offer an automatic underwriting assessment to determine if you could qualify for a QM loan. Also, ask if the lender originates its own non-QM loans or if the loan is backed by another company that will service it. It’s crucial to thoroughly understand all fees, loan terms, and features to fully grasp the overall borrowing costs.
It’s critical to carefully review and comprehend all the terms and conditions of any mortgage, but this is especially important with non-QM loans. Pay close attention to the fine print and be aware of the potential worst-case scenarios.
Conclusion: Is a Non-QM Loan Right for You?
Non-QM loans offer a valuable alternative for borrowers who don’t fit traditional mortgage criteria. While they provide flexibility and access to homeownership, it’s crucial to weigh the benefits against the potential drawbacks, including higher costs and reduced consumer protections. By understanding the intricacies of non-QM loans, you can make an informed decision that aligns with your financial circumstances and homeownership goals.
