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What Are Non-Qualifying Mortgages?

As you get started on your path to own a home, you might be overwhelmed or confused by the wealth of mortgage options available to borrowers. If you’ve been denied a mortgage because you’re self-employed or otherwise have a hard time documenting income, you might have heard of another option — a non-qualifying mortgage loan.

These loans don’t require the same standards as qualifying loans, but they do require different types of documentation. In this article, we’ll discuss the differences between qualifying and non-qualifying mortgage loans so you can decide the right option for your situation.

First, what is a qualifying mortgage?

In order to understand non-qualifying mortgages, we’ve got to start with qualifying mortgages.

Before the 2008 housing crisis, there was a huge number of “stated income” mortgages issued to buyers who weren’t required to provide any documentation to prove their income. In 2005, a full third of mortgages originated in the U.S. were stated income loans, and many of these borrowers defaulted when the housing market collapsed.

As a result, new federal rules were put in place that scraped stated income loans and instituting new “qualifying mortgage” standards. These require creditors to make a determination of a consumer’s ability to repay a mortgage loan. The standards include:

  • Maximum 43% debt-to-income ratio
  • Loan terms of 30 years or less
  • Restrictions on “risky” mortgages like interest-only or balloon loans

Qualifying mortgages generally meet the same guidelines as conforming mortgages. This term refers to loans that adhere to the standards set by Fannie Mae and Freddie Mac, the two government-supported enterprises that buy up mortgages and repackage them into securities.

All federal loans, including FHA, VA and USDA loans, also adhere to these standards. Anything that does not adhere to these guidelines is considered a non-qualifying mortgage.

Who needs a non-qualifying mortgage?

So why pursue a non-qualifying mortgage? For much the same reason you would have — legitimately — pursued a stated income loan in the past. Those loans were intended to provide a path to homeownership for self-employed people who weren’t able to show W-2s with steady income streams. Similarly, today’s non-qualifying mortgages can be a good option for these self-employed buyers.

But these days, non-qualifying mortgages require proof of income — they just aren’t as limited in the documentation they will accept. For this reason, non-qualifying mortgages are sometimes referred to as “alternative documentation” or “bank statement” loans.

For these types of loans, lenders will calculate income through analyzing bank statements, typically going back 12 to 24 months. For this reason, borrowers pursuing bank statement loans should have at least two years of self-employment history.

Another reason someone might pursue a non-qualifying loan is if they have a top-shelf credit score but don’t have a higher debt-to-income ratio or want a loan with other risky features, like interest-only payments. These folks might also be in search of a jumbo mortgage, which exceeds the loan limits of a conforming mortgage.

And finally, real estate investors who plan to buy a home, renovate and flip it back to the market or use the home as a rental property might be able to benefit from a non-qualifying loan, since investors are exempt from the ability-to-repay standards of other mortgages. These are sometimes called “cash flow” loans.

Pros and cons of a non-qualifying mortgage

Pros

  • Qualify with a higher debt-to-income ratio than the 43% that qualifying mortgages require. Bank statement loans can allow up to 55% debt-to-income ratio.
  • Easier path for self-employed buyers who might not qualify for a traditional mortgage, real estate investors who are looking for cash flow loans or high-end buyers who need a jumbo mortgage with unusual features.

Cons

  • Higher down payment required. They require at least 10% down, and sometimes as much as 25% down — compared with a standard mortgage, which is often 3%.
  • Higher interest rates. The interest rates can also be about 1% to 2% higher.

The bottom line

Non-qualifying mortgages are a growing sector of the mortgage market. Because of the additional guidelines that differentiate non-qualifying mortgages from the stated income loans of the past, S&P Global Ratings predicts that non-qualifying mortgages will open up a path to homeownership for a wide group of buyers who, through unusual circumstances, weren’t able to qualify for traditional mortgages.

If you’ve been denied a traditional mortgage due to nontraditional income, a non-qualifying or bank statement loan could be a great way to get a chance to own the home of your dreams. Still remember that since these loans don’t conform to federal standards, you want to read the terms very carefully, and make sure to compare several options from various lenders to get the deal that’s right for you.

 

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