Non-QM Loans: What They Are and How They Work
If your income or credit history falls outside the stringent guidelines set by standard mortgage loan programs, a non-QM loan may be worth considering. Non-QM is short for non-qualified mortgage, and understanding how non-QM loans work may help you decide if they’re a worthwhile financing option for you.
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What are non-QM loans?
Non-QM loans are mortgages that don’t meet the Consumer Financial Protection Bureau’s (CFPB) requirements to be considered qualified mortgages. A qualified mortgage meets the CFPB’s “ability to repay” rule, which requires that lenders vet your finances and set terms on the loan that you’re likely to be able to pay back.
Some features of non-QM loans include:
Risky features. To help you qualify for a non-QM, loan the lender may include one or a combination of the following features:
- Interest-only payments. Lenders that offer an interest-only option don’t require you to pay any of your loan balance down but instead just pay the interest accruing each month.
- Negative amortization. Although this is very rare, you may come across a lender that allows you to make payments for less than the interest charged each month. In this case, your loan balance grows, called “negative amortization” in loan terms.
- Balloon payments. You’ll make a larger-than-usual payment at the end of a set time if your non-QM loan has a balloon payment.
- Longer loan term. You may find a non-QM lender that offers terms longer than 30 years.
Higher-priced loans with upfront points and fees. To offset the higher risk lenders take making non-QM loans, you’ll likely pay higher rates, APRs and even upfront fees and points that aren’t permitted on qualified mortgages.
Flexibility with your income or credit history. While a standard QM loan requires you to verify your income with tax returns, W2s and paystubs, a non-QM lender might be able to use your bank statements to calculate income to qualify for your loan. Non-QM lenders often offer programs that allow you to borrow within days of a major recent credit event like a bankruptcy or foreclosure. You won’t have to wait the two to seven years required by qualified mortgage loan programs.
THINGS YOU SHOULD KNOW
Non-QM loans are not like subprime loans from the last housing crisis. Lenders must 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.
Pros and cons of a non-QM loan
| Pros | Cons |
|---|---|
Alternative documentation is allowed to verify income | Down payments are typically higher |
Credit requirements are more relaxed | Interest rates and costs are more expensive than standard loans |
Products are available for foreign nationals | Risky features may increase your risk of default |
Investors don’t limit the number of financed properties you own | Not all lenders offer non-QM products, which makes them harder to find |
Who benefits from non-QM loans?
Non-QM loans are handy for people who have found their dream home but were denied a home loan under qualified-mortgage standards. A non-qualified mortgage may provide a temporary lending solution until you meet regular mortgage guidelines and can refinance to a traditional loan.
Non-QM lenders offer options for:
BORROWERS WHO ARE SELF-EMPLOYED
While standard loan programs require tax documents to prove your self-employed income, non-QM lenders may offer bank statement mortgages with no need for filed tax paperwork. The lender evaluates deposits based on 12 to 24 months’ worth of personal or business statements to determine your qualifying income.
BORROWERS WITH HIGH NET WORTH
Some lenders allow you to divide the total cash balance in an asset account by a lender-chosen time period and use the result for qualifying income. This is known as an asset depletion loan. 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 may be a good choice for investors who own more than 10 financed investment properties — the limit for most conventional lenders. Other non-QM lenders offer debt-service coverage ratio loans for real estate investors. If the rent on the new home covers the monthly payment, you don’t need other income to qualify.
BORROWERS WITH RECENT BAD CREDIT
You may be eligible for a non-QM loan one day after completing a bankruptcy or foreclosure. You typically need to wait two to seven years after a significant credit event for standard loan programs.
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
Sporadic income-earners may benefit from an interest-only loan that allows for a lower payment option during times of the year when they earn less. One caveat: Your payment could increase after the interest-only period ends, making the loan harder to repay.
Qualified vs. non-qualified mortgages
If you’re trying to decide between a qualified mortgage and a non-QM mortgage, the table below gives you a side-by-side comparison of the standard features.
| Loan feature | QM mortgage | Non-QM mortgage |
|---|---|---|
| Down payment | As low as 0% | Typically 20% or more |
| Debt-to-income (DTI) ratio | Typically capped at 50% | Not required on some programs |
| Asset depletion | Not allowed | May be allowed |
| Income documentation | Filed tax documents | May allow bank statements instead |
| Credit history | No bankruptcy or foreclosure within last two to seven years | One day out of bankruptcy of foreclosure programs allowed |
| Financed property limits | 10 for conventional | No limit programs available |
Non-QM loan underwriting
There are no uniform underwriting standards for non-QM loans, and 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 the first three months of 2022 found the following common credit characteristics of closed non-QM loans:
- The average credit score was 771
- The average down payment was 24%
- The average DTI ratio for non-QM homebuyers was 37%
Moreover, CoreLogic’s analysis revealed the top three reasons borrowers chose non-QM loans:
- More flexible documentation requirements
- Higher DTI ratio limits
- Option for interest-only payments
How to avoid needing a non-QM loan
Try some of these steps to improve your chances of qualifying for a qualified mortgage, such as:
BOOST YOUR CREDIT SCORE:Pay your bills on time, and pay off credit card balances each month to help improve your credit score.
FIND A COSIGNER:If have a relative or friend willing to cosign on a mortgage with you, their income may help you meet traditional loan DTI ratio requirements.
PUT MORE MONEY DOWN:A higher down payment equals a lower loan amount and monthly payment, which may help you qualify for a standard mortgage.
GET A SIDE HUSTLE: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.
BUY A MULTI-UNIT HOME AND QUALIFY WITH RENTAL INCOME:If 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 multi-unit home with a down payment as low as 3.5%.