What are Non-Qualified Loans
What are Non-QM Loans?
When you apply for a mortgage, there are some specific income verification methods that will be required. This usually means that you need to have a steady, month-to-month income and a debt to income ratio of less than 43%.
If you don’t meet some of these criteria, you may not be eligible for qualified mortgages or QM loans. These loans have more stable features that make it more likely that you’ll be able to pay back the loan.
By contrast, non-qualified mortgages or non-QM loans don’t require the same income verification that qualified mortgages do. While this makes them more accessible for a wider range of people, they come with riskier features that can cause them to be more difficult to pay off.
Let’s take a look at everything there is to know about non-QM loans to see if they might be right and safe for you.
Elements of a Qualified Mortgage
To fully understand what a non-QM loan is and why it differs from QM loans, it’s important to look at the rules that lenders need to follow when offering up qualified mortgages. QM loans meet all the consumer protection requirements of the Dodd-Frank Act, and they’re usually only offered to individuals who have low debt-to-income ratios and stable month-to-month income.
Qualified mortgages can not have the following:
Risky loan features, or anything that might make for low monthly payments in the early years of the loan, such as balloon payments. Excess upfront costs and fees. Loan terms of longer than 30 years. Borrower’s debt-to-income ratio cannot be more than 43%. Qualified mortgages also follow the ability-to-repay rule in which lenders will assess your income, credit history, employment, assets, and monthly expenses to make a good-faith guess as far as if you’ll be able to repay the loan.
But for some people, those factors are unavailable for one reason or another. This is where non-QM loans come into play.
Who are Non-QM Loans For?
If your income varies from month to month, you have a debt-to-income ratio of more than 43%, or if you don’t meet the requirements laid out in the Dodd-Frank Act, you may not be offered a qualified mortgage.
Instead, they may offer you a non-qualified mortgage. While they will still assess your ability to pay back the loan in some way, they won’t use traditional methods as they might in the case of qualified mortgages.
The main reasons you may seek a non-QM loan are:
You have a poor credit history.
You’re an investor looking to purchase rental or vacation properties.
You have limited documentation.
Your debt-to-income ratio is higher than 43%.
You have non-traditional income or are living off of investments.
Refinance after foreclosure
Pros and Cons of Non-QM Loans
Non-QM loans are naturally riskier than qualified mortgages because there is less evidence that a borrower is reliable and will pay the loan back. With that said, they are sometimes the best options. Let’s look at some pros and cons.
The main advantage of non-QM loans is that they make mortgages more accessible. Small business owners or freelance workers who don’t make traditional income have historically had difficulty securing mortgages, but non-QM loans open the door for a wider audience.
Additionally, they require less formal documentation than other types of loans. These usually won’t require things like W-2s, employment verification, or tax return documents. However, they may ask for alternative forms of income like bank statements or assets.
Not to mention, they often come with more flexible terms, including balloon payment options and variable loan terms, which are often not available when it comes to most qualified mortgages.
On the flip side, the biggest drawback of non-QM loans is that they come with higher interest rates. This is because they are riskier loans for the lender, so they want to make sure that they can still make money off of the loan even if you default at some point. Not to mention, they usually require higher down payments as well.
These loans also come with risky features, such as interest-only payments that can increase your chance of defaulting. This makes them tougher for you as a borrower to pay back. And if you happen to default, it can ruin your credit score.
Non-QM loans are also difficult to find since many lenders don’t offer them. Again, this is because they can be very risky for the lender, as they need to use a lot of good-faith judgment to determine if you’ll reliably make your payments on time.
Are Non-QM Loans Safe?
There is a common misconception that non-QM loans are “bad.” This stems from the fact that they tend to have riskier features than qualified mortgages, which is natural given the different eligibility requirements.
The truth is that both qualified and non-qualified mortgages have a similar lending process; they just differ in their required documents.
Non-QM loans are great options for some people with specific circumstances that prevent them from being able to secure qualified loans. You just need to be aware that they are likely to have higher interest rates and down payments.
Are Non-QM Loans the Same as Subprime Mortgages?
One of the reasons for the stigma against non-QM loans is that they are often confused with subprime mortgages. These are loans that are issued to borrowers with low credit scores, usually under 640. It has nothing to do with income or employment history.
While the word “subprime” may sound like it equates to lower interest rates, it actually refers to a poor-quality loan. Subprime mortgages are a large risk for the lender, so they typically come with higher interest rates and closing costs compared to conventional loans.
The Oak Tree can alleviate some of the closing cost burdens by offering home mortgage programs with $0 lender fees. Not to mention, we’re fast, letting you close on your home in as little as 15 business days.
Risks of Subprime Mortgages
Lenders are always distrustful of people with bad credit histories because it raises a red flag that they may be unable to pay back the loan. To compensate for potential losses, they introduce high closing costs and increased interest rates.
The average interest rate of a 30 year fixed rate mortgage is around 4%. Compare this to the average interest rate of a subprime mortgage, which falls somewhere around 10%. This is a stark increase, making subprime mortgages extremely unattractive.
Additionally, subprime mortgage lenders can charge as much as 35% down on the home, compared to just 10-20% for conventional loans. With that said, subprime down payments can also go as low as 3%. It really varies by lender, so you should shop around to look for the best rates.
If it sounds difficult to pay back a subprime mortgage, it’s because it is. People defaulting on subprime mortgages was actually a huge factor in contributing to the housing crisis of 2008, so these types of loans exist much differently today.
Non-QM loans are mortgages that are meant for people who don’t meet the eligibility requirements of QM or qualified mortgages. Typically, borrowers have low credit scores, non-traditional income, and high debt to income ratios.
Because of the risk for the lender, non-QM loans have riskier features compared to QM loans. This includes higher interest rates, higher down payments, and balloon payments for the lender to maintain income even if the borrower defaults. With that said, they come with flexible terms and can supply mortgages for more people.
Non-QM loans are not subprime mortgages, meaning that they are safe options for those who don’t meet traditional lending criteria. Despite higher payments, many people seek non-QM loans and are able to pay them off normally.
With that said, you still have other options like owner financing, FHA loans, VA loans, or refinancing. And you can work to avoid needing a non-QM loan by strengthening your credit, putting forth a higher down payment, or getting a co-signer.
Sources: Dodd-Frank Act | CFTC What is a subprime mortgage? | Consumer Financial Protection Bureau The 2008 Housing Crisis | Center for American Progress