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Non-QM Loans: What They Are and How They Work

If you have a complicated income history or major credit bumps in your past, you’ll have a harder time being approved for a qualified mortgage, or QM. That’s where a non-QM loan (short for non-qualified mortgage), comes in.

Non-QM loans don’t meet federal standards to be considered qualified mortgages, which have stringent rules to establish a borrower’s ability to repay a home loan.

What are non-QM loans?

Non-QM loans don’t meet the requirements set by the Consumer Financial Protection Bureau (CFPB) to be considered qualified mortgages. That means they don’t satisfy one or more of the following requirements:

  • The points and fees for loan amounts of $100,000 or more are less than or equal to 3%
  • The loan cannot have risky features like negative amortization, interest-only payments or a balloon payment
  • The term of the loan must be 30 years or less
  • The debt-to-income (DTI) ratio must be 43% or less

One important note: Non-QM loans are not like subprime loans from the last housing crisis. Lenders are still required to make a good-faith effort to verify you can repay the loan. However, non-QM lenders can create their own guidelines to prove you can afford the monthly mortgage payments.

What are the benefits of non-QM loans?

If you’ve found your dream home but were denied a home loan, a non-QM product may be worth considering. A non-qualified mortgage may provide a temporary lending solution until you meet standard mortgage guidelines and can refinance to a traditional loan.

Non-QM lenders offer more loan options for:

Borrowers who are self-employed

Instead of tax returns, non-QM lenders offer bank statement mortgage loans. With 12 to 24 months’ worth of personal or business statements, the lender evaluates deposits to determine your qualifying income.

Borrowers with high net-worth

Some lenders offer asset depletion programs. By dividing your total cash balance by a lender-chosen time period, the asset is counted as income. For example, a $200,000 savings balance may be converted into $833.33 of extra monthly qualifying income with a typical 20-year asset depletion loan term.

Borrowers investing in multiple rental units

Non-QM loans come in handy if you’re building a portfolio of investment properties but already own 10 mortgaged properties — the limit for most conventional lenders. Some lenders also offer debt-service coverage ratio loans for real estate investors. If the rent on the new home covers the monthly payment, you won’t need to verify any other income to qualify.

Borrowers with recent bad credit

You may qualify for a non-QM loan one day after completing a bankruptcy or foreclosure. For standard loan programs, you typically need to wait two to seven years after a significant credit event.

Borrowers who are foreign nationals

A foreign national is a citizen of another country who lives in the U.S. for brief periods for work or vacation. Non-QM loans for foreign nationals may not require proof of U.S. income, credit or a Social Security number.

Borrowers who want an interest-only payment option

If your income is sporadic, an interest-only loan gives you a lower payment option during times of the year when you earn less. Qualified mortgage rules prohibit them, and with good reason: Your payment could increase after the interest-only period ends, making the loan harder to repay.

Understanding non-QM underwriting guidelines

While there are no uniform underwriting standards for non-QM loans, lenders tend to specialize in certain types of non-QM products. Interest rates and loan terms may vary widely from lender to lender. Data compiled by CoreLogic in 2019 found the following common credit characteristics of closed non-QM loans:

  • The average credit score was 760
  • The average down payment was 21%
  • The average DTI ratio for non-QM homebuyers was higher in contrast to the DTI ratio for QM homebuyers

Moreover, CoreLogic’s analysis revealed the top three reasons borrowers choose a non-QM loan:

  1. More flexible documentation requirements
  2. More lenient DTI ratio limits
  3. Option to choose interest-only payments

Pros and cons of QM loans vs. non-QM loans

Pros of QM loans  Cons of QM loans 
  Down payments are typically lower.   Documentation requirements for self-employed borrowers are extensive.
  Interest rates may be lower because the loans are less risky.   Credit requirements are stricter.
  Multiple lenders are available because of government backing and sponsorship.   Products aren’t available to foreign nationals.
  Risky features are prohibited.  Investors are limited to financing no more than 10 properties.
Pros of non-QM loans Cons of non-QM loans
  Alternative documentation is allowed.   Down payments are typically higher.
  Credit requirements are more relaxed.   Interest rates and costs are usually more expensive.
  Products are available to foreign nationals.   Risky features (such as interest-only payments) may increase your risk of default.
  Investors are not limited by the number of financed properties they own.   Non-QM products may be harder to find.

Where do I find non-QM lenders?

Because mortgage brokers usually work with a variety of different lenders, they’re often a valuable resource for finding non-QM loan products. However, interest rates and fees can vary. Contacting at least two or three mortgage brokers to review cost estimates should give you a good baseline for whether you’re getting a good deal.

Non-QM loans may be harder to find during times of economic turmoil, because widespread financial uncertainty may cause non-QM lenders to temporarily suspend their loan offerings.

How to avoid needing a non-QM loan

Here are some steps you can take to improve your chances of qualifying for a qualified mortgage, such as:

BoostING your credit scoresPaying bills on time, and paying off credit card balances each month may help improve your credit score.

FindING a co-borrower Adding the income of a co-borrower may help you meet traditional loan DTI ratio requirements.

PutTING more money down A higher down payment equals a lower loan amount and monthly payment. That may help you qualify for a standard mortgage.

GetTING a side hustle The extra money from a second job may help you save more money for a down payment. If you can document continuous income from a second or part-time job for the past two years, it may also count toward your qualifying income.

buyING a multiunit home and qualifyING with rental incomEIf you want to live in a two- to four-unit home, the rent from the other units may help you qualify for a mortgage. Even better: Some programs let you buy a multiunit home with a down payment as low as 3.5%.

 

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