Some homebuyers don’t fit the typical mortgage criteria, often due to factors like creditworthiness, income level, or income stability. For these situations, a non-qualified mortgage (non-QM) can be a suitable alternative. Non-QM loans generally have more flexible credit and income requirements but may require higher down payments and interest rates. Additionally, they might lack some of the consumer protections found in standard mortgages.

What is a non-qualified mortgage?

A non-qualified mortgage (non-QM) is a type of mortgage that doesn’t adhere to the standards established by the Consumer Financial Protection Bureau (CFPB). These standards define the features that loans may have and outline the practices lenders must follow when assessing applicants’ finances and repayment ability. Examples of non-QM loans include asset-based loans and no-income verification loans.

Non-QM lenders have more flexibility in their underwriting criteria compared to conventional lenders. They are willing to work with borrowers who may be considered too risky by traditional lenders due to factors like irregular income, low credit scores, or a troubled credit history, or those who simply don’t meet the requirements for qualified mortgages.

What are the features of a non-qualified mortgage?

Non-QM loans offer more flexible income and credit requirements compared to traditional mortgages. For instance, instead of relying on W-2 forms and pay stubs, borrowers might use alternative documentation such as tax returns, bank or investment account statements, rental income, or 1099s to prove their ability to repay the loan.

Additionally, borrowers may have higher debt-to-income ratios, potentially up to 50%, compared to the limits preferred by conventional lenders.

In some instances, non-QM loans have no waiting period following bankruptcy or foreclosure, allowing individuals to obtain a mortgage shortly after these events.

How does a non-qualified mortgage differ from a qualified mortgage?

A qualified mortgage (QM) is a loan that meets specific criteria established by the CFPB. These guidelines are intended to ensure the borrower’s ability to repay the loan and include restrictions on negative amortization, interest-only payments, and balloon payments. QMs also mandate that loan terms do not exceed 30 years and require verification of income and assets.

The QM rule encompasses four main requirements that lenders must adhere to:

The “ability-to-repay” rule

Before approving a loan, lenders must ensure that the borrower can genuinely afford the financing by verifying and documenting key aspects of their personal finances, a process known as underwriting. The ability-to-repay rule requires lenders to assess loan applications based on these eight factors:

  • Current income and assets
  • Current employment status
  • Monthly mortgage payment
  • Monthly payments on any additional loans secured by the home, such as a piggyback mortgage
  • Monthly payments for mortgage-related obligations
  • Current debt obligations, including alimony and child support
  • Monthly debt-to-income ratio or residual income
  • Credit history

Restrictions on risky features

These include:

  • Loan terms extending beyond 30 years
  • Interest-only payments that do not reduce the principal
  • Balloon payments, which require a large lump-sum payment at the end of the loan term
  • Negative amortization, where the loan balance increases over time

Caps on fees and points

Lender fees and points can significantly raise your borrowing costs. For loan amounts over $100,000, these fees and points must not exceed 3% of the loan amount.

Limits on debt-to-income ratio

The debt-to-income (DTI) ratio, expressed as a percentage, is calculated by dividing your total monthly obligations by your pre-tax monthly income. Generally, a qualified mortgage borrower is restricted to a maximum DTI ratio of 43%.

Non-QM loans, however, do not adhere to these standard rules. They often have more flexible requirements for credit scores, DTI ratios, and repayment schedules. Nevertheless, non-QM loans can come with longer terms, balloon payments, and higher fees.

Is a non-qualified loan the same as a non-conforming loan?

Non-qualified loans and non-conforming loans are different types of mortgages that fall outside the standard loan categories, but they are governed by different sets of rules.

A non-QM loan does not adhere to the Consumer Financial Protection Bureau (CFPB) standards, which are designed to protect consumers from predatory lending practices and ensure they can afford the loans they take out.

In contrast, a non-conforming loan does not meet the criteria set by the Federal Housing Finance Agency (FHFA). As a result, it is not eligible for purchase by Fannie Mae or Freddie Mac, the two government-sponsored enterprises that buy most of the home loans in the U.S. One key criterion set by the FHFA is that the loan amount must not exceed a certain limit—$766,550 in most areas of the U.S. in 2024.

While there is some overlap between the standards of the FHFA and CFPB, such as requirements for borrower finances and creditworthiness, the two sets of rules serve different purposes. For example, a conforming loan typically requires a debt-to-income (DTI) ratio of no more than 43 percent, proof of salaried income, and a certain credit score. Loans that feature non-traditional aspects, like terms other than 15 or 30 years or no down payment, are usually classified as non-conforming.

In summary, non-conforming loans are a subset of non-QM loans that do not fit the conventional mortgage framework.

Who can benefit from non-qualified mortgages?

CFPB’s Qualified Loan standards are designed to protect consumers, but they may not suit everyone, particularly those with unconventional financial profiles. If traditional or government-insured loans have been out of reach, a non-QM lender might offer a solution.

Here are some groups who might benefit from a non-QM loan:

  • Self-Employed Borrowers: Individuals with irregular income from multiple sources often struggle to qualify for conventional mortgages. Non-QM loans, like bank statement loans, evaluate cash flow and liquid assets instead of relying solely on W-2 forms.
  • Real Estate Investors: Investors who buy, renovate, and sell homes or generate rental income may need quick funding. Non-QM loans, such as DSCR (debt service coverage ratio) loans and asset depletion home loans, can cater to these needs by excluding traditional ability-to-repay rules.
  • Foreign Nationals: Non-residents wishing to buy property in the U.S. may not qualify for standard loans due to a lack of U.S. credit history. Non-QM lenders use international credit reports and other financial documentation to qualify these borrowers, considering factors like high income and substantial down payments.
  • Prime Borrowers: Those with excellent credit seeking loans with features not available in traditional mortgages, such as interest-only payments or higher debt-to-income ratio limits, can find what they need with non-QM options.
  • Near or Non-Prime Borrowers: Borrowers with poor credit, recent bankruptcies, or distressed property sales might face stricter requirements and higher down payments with non-QM loans. These loans offer a way to overcome traditional barriers.
  • Borrowers with Significant Assets: For those with substantial assets but a minimal credit history, asset qualifier loans can be ideal. These loans allow for financing despite having enough assets to purchase a home outright, helping to maintain positive cash flow. This category also includes credit invisibles—individuals with considerable assets but limited credit use.

How do lenders verify income for non-qualified loans?

For qualified loans, income verification usually involves examining tax returns, W-2s, and pay stubs. In contrast, non-QM loans use a more flexible approach. Through manual underwriting, lenders may accept alternative income documentation such as bank or investment account statements, 1099s, rent or lease receipts, and other business income records to assess a borrower’s ability to repay the loan.

What are the drawbacks of a non-QM loan?

Non-QM loans can serve as a viable alternative to conventional financing, but they come with notable costs. These loans often require larger down payments—up to 25% of the home price—and higher interest rates.

Interest rates on non-QM loans can vary significantly, ranging from just 0.25% above qualified mortgage rates to as much as 5% higher, depending on transaction terms and borrower creditworthiness. Typically, non-QM 30-year fixed-rate loans are priced 1% to 2% higher than prime 30-year fixed mortgages, according to Fitch Ratings.

These higher rates and down payment requirements help compensate lenders for the additional risk, as Fannie Mae and Freddie Mac do not purchase non-QM loans.

Pros:

  • Easier to obtain
  • Accessible to non-traditional borrowers
  • More flexible terms

Cons:

  • Harder to find reputable lenders
  • Higher interest rates and down payments
  • Potentially more challenging repayment

Additionally, lenders must still conduct thorough due diligence to avoid CFPB enforcement actions related to inaccurate verification of a borrower’s ability to repay. Borrowers should also be aware that non-QM loans can be riskier due to features like balloon payments and interest-only repayments, which can lead to increased likelihood of delinquency and default. Overall, non-QM loans are generally more expensive compared to traditional mortgages of similar size and term.

Where can you get a non-QM loan?

If you’re considering a non-QM loan, there are several steps you can take to find the right option. Start by assessing your eligibility, which generally includes a minimum credit score of 620, stable income, and a consistent employment history.

Once you confirm that you meet these criteria, begin your search for lenders that offer non-QM loans. Mortgage brokers often work with non-QM wholesale lenders and can be a valuable resource.

When you identify potential lenders, ask if they can first conduct an automatic underwriting process to determine if you might qualify for a traditional loan. Also, inquire whether the lender originates its own non-QM loans or if the loan is serviced by another company. Be sure to understand all associated fees and any special terms or features that could impact your overall borrowing costs.

It’s crucial to fully understand the terms of your mortgage. With non-QM loans, it’s especially important to read the fine print and be aware of potential worst-case scenarios.