What is a Non-Qualified Mortgage (QM) Loan?

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Most loans are relatively straightforward with fixed terms and interest rates at prevailing rates, or adjustable rate loans are for those who want more flexibility according to their unique situations.

However, some borrowers may not get approved for these types of loans due to an iffy credit score or an irregular income stream. They present a more significant risk for borrowers, creating challenges for both sides of the lending process.

In these circumstances, a good solution may be a non-qualified mortgage loan, also known as a non-QM loan.

What is a Non-QM Loan?

Simply put, a non-QM loan is a mortgage that doesn’t meet the standards detailed in the Qualified Mortgage rule adopted by the Consumer Financial Protection Bureau in 2014. 

To meet Qualified Mortgage standards, lenders must first document borrowers’ income, employment status, credit, debts, and assets to make sure that these borrowers can afford to repay their mortgage.

Terms must be straightforward as well. It cannot come with riskier features such as interest-only payments or a large balloon payment due after a set number of years.

Borrowers with income streams that are hard to document or those with credit blemishes are considered riskier. However, they can still qualify with different terms that fall into the non-QM category.

Good Candidates for Non-QM Loans

For example, borrowers who want an interest-only loan, whose payments only go toward paying interest and not principal, must apply for a non-QM loan. The same goes for a negative amortization loan, in which the monthly payment is smaller than the interest accrued during that month.

Loans with longer terms, such as 40-year mortgages, are also lumped in the non-QM category.

Non-QM loans are considered riskier and will have terms to reflect that risk, but they may make more sense for some buyers. Those who plan to move after a short period or expect to earn a significantly higher salary in the next few years might benefit from interest-only mortgage rates and lower monthly payments that come with these products.

Business owners, those working in the gig economy, and tech employees whose compensation is primarily based on stock options are typical borrowers who may seek a non-QM loan.

 Non-QM Loan Pros and Cons

Pros of Non-QM Loans

  • Allow more borrowers a way to finance a home purchase
  • A good fit for someone without great credit, bankruptcy, or loans that have gone into collections
  • Takes into account irregular revenue streams
  • Borrowers often do not need to submit copies of tax returns or W2s.
  • Offer terms and features that QMs do not, such as 40-year loans
  • A streamlined application means loans often close in 30 days or less
  • Borrowers with multiple existing debts may be able to use a non-QM mortgage loan to consolidate debt 
  • QM loans allow a debt-to-income ratio of up to 43 percent, but non-QM loans can exceed that ratio
  • You typically must wait 7 years after a foreclosure to get a QM loan, but you may be able to get a non-QM loan almost immediately
  • You can own multiple properties without it being used against you

Cons of Non-QM Loans

  • Higher interest rates of 1-2% or more
  • More difficult to obtain than a QM loan
  • May require a larger downpayment of as much as 20% in some cases
  • Lenders must still verify borrowers can afford monthly payments
  • Banks keep non-QM loans on their books instead of passing them along to entities such as Fannie Mae or Freddie Mac
  • Fewer consumer protections than qualified mortgages
  • Self-employed borrowers or those who rely on commission and bonuses may have to show two to three years of earning history to qualify for a QM loan. However, recent rule changes mean the self-employed may show a shorter income history proven with checking account deposits instead of tax returns.
  • Non-QM lenders and products can be harder to find

What is the QM Rule?

The QM rule, sometimes known as “ability to repay,” ensures that borrowers are not sold mortgages with features that can cause them to become unaffordable. Mortgages with “toxic” features were widely blamed for playing a major role in the housing bubble and subsequent crash a few years ago.

To be considered a qualified mortgage, a home loan cannot include such risky features as negative amortization, balloon payments, or an interest-only feature. Loans that meet QM guidelines provide the lenders with certain legal protections in the event of foreclosure; specifically, the homeowner cannot sue them, claiming they were sold an unaffordable loan.

This protection allows lenders to offer QMs at lower rates than loans that do not meet such guidelines.

QM loans can also not exceed 3% in fees, while non-QM loans do not have that cap. Banks can charge fees higher than 3% to borrowers with low credit scores to offset the higher risk posed by these types of borrowers.

A Final Thought

Non-QM loans can be a viable alternative for borrowers who do not qualify for traditional mortgages or need more flexibility with a mortgage loan. However, borrowers should thoroughly weigh the pros and cons and aggressively shop for a lender with the best terms for their financial situation.

Kara Johnson

Kara is a Rye, New York-based author and contributing writer for Refi.com. She is a graduate of Hampshire College.

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