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

Published on: May 11, 2022

non qm loans

After the Great Recession, the federal government created stricter underwriting rules to ensure mortgage borrowers have the ability to repay their home loan. However, non-qualified mortgages, also called non-QM loans, are an option for borrowers who don’t qualify for a traditional loan, either because they have a high debt-to-income ratio, are self-employed, or earn nontraditional income.

What are non-QM loans?

A non-QM loan is a mortgage that doesn’t meet the requirements for a qualified mortgage (QM). However, Finance of America Mortgage and other non-QM lenders still establish a borrower’s ability to repay the loan, but they do so in different ways. 

To better understand what a non-QM loan is, let’s look at the parameters of a qualified mortgage, including: 

  • The loan has a term of 30 years or less. 
  • The total points and fees charged are 3% or less of the loan amount. 
  • The lender verifies and documents the assets and income the borrower will use to repay the loan. 
  • The loan cannot have negative amortization, be interest-only, or have a balloon payment. 
  • The borrower has a debt-to-income ratio of 43% or less.* 
  • The lender can’t use an introductory or “teaser” interest to determine the buyer’s ability to pay off the loan. 

*After Oct. 1 2022, this rule will expire in favor of a limit based on the loan pricing; the annual percentage rate on non-QM loans will be capped at 2.25 percentage points above the average prime offer rate. 

These rules, also called the ability-to-repay requirements, were created to ensure that borrowers don’t end up with a mortgage they can’t afford, putting them at risk of foreclosure.  

However, some borrowers have difficulty verifying their income or employment, because they don’t earn regular wages. For example, self-employed workers or those who earn hefty commissions may make enough money overall to afford the mortgage, but their income may be unpredictable. Retirees may have a lot of cash but not much income. 

When you apply for a non-QM loan, your lender will review your credit, income, and assets and must still ensure you have the ability to repay the loan. However, the lender may accept alternative documentation that isn’t allowed for a QM mortgage, such as bank statements and profit-and-loss statements. Finance of America Mortgage offers proprietary non-QM loans through a suite of products called Two-X Flex.

Contact a local Finance of America Mortgage Advisor today to learn more about our non-QM offerings.

Comparing qualified vs. non-qualified mortgages

Term  QM loan  Non-QM loan 
Permitted DTI  43%  None listed 
Income verification  Yes  Yes* 
Permitted loan terms  30 years max  None listed 
Asset verification  Yes  Yes* 
Points and fees limit  3% of loan or less  None listed 
Balloon payment OK  No  Yes 
Negative amortization OK  No  Yes 

(*) Lenders must make a “good-faith effort” to ensure you’ll be able to repay the loan.

When you apply for a qualified mortgage, the lender will require documents that prove the income and assets you’re claiming and your current debt obligations. You’ll probably have to provide W-2 forms, bank statements, and income tax returns. With a non-QM loan, the lender may accept alternative income documentation in lieu of W-2 forms.

The interest rate and fees you pay with a non-QM loan may be higher than with a qualified mortgage. The total points and fees on a QM are capped at 3% of the mortgage, as long as you’re borrowing more than $100,000. No such cap exists for non-QM loans.

Where can you find non-qualified mortgage lenders?

Various kinds of lenders offer non-qualifying mortgage loans. They include:  

Small lenders. The law governing QM loans carves out an exception for small creditors with less than $2 billion in assets that originate fewer than 500 loans annually. These lenders can make and hold loans in their portfolio as long as they have verified the borrower’s debt-to-income ratio; the law doesn’t provide a DTI limit for these institutions. 

Mortgage lenders. Some lenders offer both QM loans, which they sell, and non-QM loans, which they keep in their portfolio. They charge higher fees and interest rates for non-QM loans.  

Credit unions. Credit unions are member-owned and don’t always sell their loans, so their mortgages don’t need to be qualifying mortgages. If you’re a credit union member, the loan officers may be willing to work with you. 

Agencies that specialize in low-to-moderate-income buyers. Certain lenders are exempt from the ability-to-pay rules, including state housing finance agencies, some nonprofits, and community development financial institutions. The exemption allows them to make loans to individuals who may have a higher DTI or lower credit score than needed for a qualified loan.

Who might qualify for a non-QM loan?

If you have a steady income from a salaried job, a DTI of less than 43%, and a good credit score, you’re a good candidate for a traditional qualified mortgage. 

However, many people who have a good income or numerous assets might not meet the requirements for a QM. They may be candidates for a non-QM loan.  

Borrowers who might benefit from a non-qualified mortgage include: 

  • Borrowers whose income is not predictable. People who are self-employed, work on commission, or earn a lot of overtime may have a harder time meeting the standard QM income requirements to show they earn enough to pay back the loan. 
  • Small business owners. They may have tax deductions that reduce the income shown on their tax forms, or they may have all their money tied up in equipment for their businesses. 
  • Retirees. Retired people may have money in the bank or retirement accounts but little income.  
  • People with bad credit. Borrowers with a foreclosure or bankruptcy on their credit record may decide it’s worth paying higher fees and interest rates rather than waiting for the blemish to drop off their credit report. 
  • Non-U.S. citizens. They may not have the credit history or tax records needed to receive a QM. 
  • Real estate investors or others with a high debt-to-income ratio. Individuals who have a lot of outstanding loans but still have adequate income may need to get a non-QM loan. 

In many measures, borrowers with non-QM loans are similar to those with QM loans. For example, non-QM borrowers had an average credit score of 760 in 2018, compared to 754 for QM borrowers, CoreLogic reported. On average, non-QM buyers made a 21% down payment that year, while borrowers with a qualified mortgage put down an average of 19%. 

The trade-off for getting a non-QM loan is you will pay higher fees and a higher interest rate than with a qualified loan. If you prefer not to take out a non-qualified loan, you may need to improve the issues that prevent you from receiving a QM. 

  • If your credit score is too low, take steps to improve it 
  • If your DTI is too high, reduce it by paying off debts. 
  • If you don’t have enough for a down payment, wait to buy a house until you can save more. 

Consider whether a government-backed loan would work for you. Government-backed mortgages, such as programs from the FHA and USDA, help homebuyers with low credit scores or limited savings for a down payment.

Non-QM loan FAQs

Are non-QM loans safe?  

Yes, non-QM loans are safe. Lenders must determine that you will be able to pay off the loan, but they may accept alternative documents as proof.  

What is the QM rule? 

The QM rule, also called the ability-to-repay rule, requires lenders to determine that a borrower can repay a mortgage before the lender issues the mortgage. In addition, a QM loan can’t have features that are considered “risky,” such as being an interest-only loan, where you pay only interest and don’t reduce the principal. Negative amortization, where the principal can increase while you’re making payments, is also prohibited.

Lenders also establish ability to repay with non-QM loans, but they might do so by allowing documentation that’s typically not accepted for QM loans. 

What disqualifies a loan from being a qualified mortgage? 

A loan is a non-qualified mortgage if it doesn’t meet the requirements for a qualified mortgage. Those qualifications include: 

  • The loan must be for 30 years or less. 
  • Points and fees can’t exceed 3% of the loan amount. 
  • The loan can’t have interest-only, balloon payments, or negative amortization. 
  • Your debt-to-income ratio must be below 43%. 
  • The lender must verify your income, assets, and debt. 
  • The lender must make sure you can afford all mortgage-related costs for the first five years of the loan. 

Don’t fit in the traditional lending box? Talk to a local Finance of America Mortgage Advisor today to ask about FAM’s Two-X Flex suite of proprietary mortgages, including non-QM options.

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