Mortgage lenders are a diligent bunch. Given the stringent validation requirements incorporated into the mortgage process, anyone who has obtained a home loan can probably attest to that.
Lenders want to know for sure that you will be able to repay your mortgage before they will consider anything else. But not all mortgages demand such thorough examinations of borrowers’ financial situation. Non-qualified mortgages, also known as non-QM loans, are somewhat controversial in the lending industry, and not all lenders offer them.
To answer that question, you must first understand how non-qualified mortgages operate, including the dangers they pose, who qualifies for them, and how they affect mortgage rates.
What is a non-qualified mortgage?
A non-qualified mortgage might be a good fit for you, depending on the type of mortgage you’re interested in and the specific loan terms you’re looking for.
A home loan that does not have to adhere to the Consumer Financial Protection Bureau’s (CFPB) agency-standard documentation requirements is known as a non-qualified mortgage, or non-QM.
Non-QM loans may encapsulate a wide variety of mortgages, including:
Non-QM loans may also exceed the CFPB’s current price-based thresholds:
Lenders of non-QM loans do not have to make a good faith determination regarding the borrower’s capacity to repay the loan because those agency-standard documentation requirements are avoided. “Good faith determination” in this context typically refers to examining W2 forms, pay stubs, bank statements, and other records that attest to your ability to eventually pay back your mortgage.
You would be 100% correct in thinking that sounds like a risky move. The CFPB does not provide protection to homebuyers who use non-qualified mortgages. However, lenders are able to offer more flexible income requirements with higher interest rates set to offset the increased risk because non-QM loans are not constrained by those CFPB rules.
A brief history of non-qualified mortgages
To truly comprehend non-QM loans, we must first review a brief history lesson. Before the Great Recession, mortgage lenders had much more latitude to grant home loans to borrowers with less desirable qualifications, such as those with poor credit scores, high debt loads, and occasionally even no income. Lenders would charge higher interest rates on their loans in exchange for approving mortgages for these people.
The ability of loan applicants to repay the full amount of the loan would then be rated by lenders. A higher likelihood of repayment indicated a better rating, which reduced the lender’s risk. “Prime” mortgages were granted to borrowers with excellent credit scores, manageable debt, and steady income.
Homeowners who didn’t fit that description were given “subprime” mortgages, putting them at a higher risk of default. The catch was that because subprime loans carried higher interest rates, lenders were able to make more money while providing credit to a wider range of prospective homeowners.
When subprime borrowers discovered they couldn’t afford to make their monthly mortgage payments, defaults and foreclosures frequently occurred. Although subprime loans were not the main cause of the 2008 housing crisis, they undoubtedly had a significant impact.
Non-QM Loans After the 2008 Housing Crisis
In the wake of that crisis, Congress passed legislation that made significant changes to a wide range of industries, including mortgage lending. The creation of the CFPB was specifically influenced by the Frank-Dodd Act. In response, the CFPB established guidelines to stop consumers from obtaining mortgages they cannot afford.
The Ability-to-Repay/Qualified Mortgage Rule (ATR/QM Rule) is the most important of these regulations, and it requires lenders to make a “good faith determination” regarding a borrower’s ability to repay a loan before extending a residential mortgage. Checking bank statements, employment status, revolving debt, and many other things are included in that.
Home loans are essentially split into two categories by this rule: qualified mortgages and non-qualified mortgages.
Non-QM Mortgages: How Do They Work?
Non-QM loans are essentially the new subprime mortgage, albeit with a different name. Lenders who offer non-qualified mortgages are not required to verify income, examine debt, or perform other invasive financial investigations. Although that sounds bad and many people would benefit more from a qualified mortgage, there are some circumstances in which it may make sense to obtain a non-QM loan for the purpose of purchasing a home.
For instance, self-employed professionals may find it challenging to comply with a lender’s requirements for income documentation. When trying to obtain financing for a new home, you might encounter more resistance if your income varies quite a bit from month to month. Going this route may make it simpler to obtain a mortgage because non-QM loans have more lenient financial verification requirements.
There are still some financial institutions that provide non-qualified mortgage loans for residential purchases even though many lenders have shied away from subprime and non-qualified mortgages. When compared to other home loans, you should anticipate paying a significantly higher interest rate on these types of mortgages.
Don’t forget that you won’t have the same level of legal protection that qualified mortgages do. You cannot simply claim that your lender took advantage of your financial situation if you default on a non-QM loan.
Keep in mind that government backing for non-QM loans is completely absent. You cannot obtain a mortgage that is supported by the FHA, VA, Freddie Mac, or Fannie Mae if you choose this course of action.
Qualified vs. Non-Qualified Mortgages
Borrowers must meet lenders’ credit score thresholds to qualify for a loan; lenders may extend mortgages to people with low or no credit; qualified mortgages may be backed by government loan programs like VA and FHA loans; non-qualified mortgages are not eligible for VA, FHA, and other government loan programs; lenders must abide by ATR rules; lenders are not required to abide by ATR rules; lenders require extensive income documentation; lenders may not verify income.
Pros and Cons of Non-QM Loans
For borrowers, non-qualified mortgages represent a situation of high risk/high reward. You should probably avoid taking a chance on a non-QM loan if you can satisfy your lender’s loan eligibility requirements.
A non-qualified mortgage could offer a viable route to homeownership for people who, for a variety of reasons, may not fit the profile of a typical borrower. In either situation, carefully weigh the benefits and drawbacks before deciding:
Pros
Cons
Qualifying for Non-QM Mortgages
The purpose of non-qualified mortgages is to give people who wouldn’t typically meet standard lending requirements a way to secure financing on a new home. A better question might be who doesn’t qualify for a non-QM loan. However, borrowers who are drawn to non-QM loans typically fit into a few different categories.
Non-QM Mortgages: Who Benefits?
Non-QM Mortgages Over the Years
Despite the fact that non-qualified mortgages are relatively new, there have been some significant non-QM trends that potential homebuyers should be aware of. Most notably, non-QM activity suffered greatly at the height of the COVID-19 pandemic.
It is understandable that lenders became more risk-averse given the state of the economy at the time and the uncertainty surrounding the future of the labor market. But even non-QM loan providers became more selective about the applicant qualifications they would accept.
Therefore, non-QM loans were a little bit harder to find in 2020. However, as the economy improves and communities reopen, these trends have started to reverse.
Home loans that don’t adhere to the CFPB’s lending guidelines are referred to as non-qualified mortgages. Non-QM loans in particular permit lenders to confirm a borrower’s capacity to pay back a loan through alternate channels that would not otherwise be permitted. This results in a significantly less stringent application review procedure; in some circumstances, you might not even need to provide evidence of employment or income to be eligible for a non-QM loan.
There are some clear tradeoffs to consider, though. Because you can’t be certain you can afford your mortgage, you may be more likely to default on these loans. Additionally, lenders will compensate for that risk by increasing the interest rate on your mortgage.
Truth be told, the majority of borrowers with stable employment should stick with conventional mortgages rather than take a chance on a non-QM loan. If you already meet the requirements set forth by your lender, for example, for a 30-year fixed-rate mortgage, there is really nothing to gain.
If your financial situation or employment situation prevents you from being approved for a conventional home loan, non-QM loans make a lot more sense. However, before making a final choice, you should always speak with a mortgage specialist who can help you balance the benefits and risks.
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FAQ
What are the benefits of non-QM loans?
One of the main advantages of a non-QM loan is that it makes it possible for buyers with bad credit to buy a house. People who are self-employed, own their own businesses, or hold unconventional jobs are exempt from providing proof of income. Nearly as simple to apply for as a conventional loan are non-QMs.
What does no QM mean?
A non-QM loan may be worth considering if your income or credit history don’t meet the strict requirements of standard mortgage loan programs. Understanding how non-QM loans operate can help you determine if they’re a good financing option for you. Non-QM stands for non-qualified mortgage.
Are non-QM loans more expensive?
Traditional mortgages are more expensive than non-QM loans, both initially and over time. Due to the frequently higher costs of points and fees associated with non-QM mortgages, you’ll almost certainly pay higher closing costs and have a rate that is significantly higher than you would with a conventional mortgage.
What is the difference between QM and non-QM?
A Non-QM loan uses different methods of confirming income than a QM loan, which is a significant difference between the two types of loans. To assist the borrower in receiving mortgage loan approval, use the common methods of income verification for a QM loan.