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If you’re having difficulty qualifying for a mortgage — especially due to your credit, income level or income predictability — a non-qualified mortgage, or non-QM for short, can fill the gap. While non-QM loans offer more lenient credit and income requirements, they also come with higher down payments and interest rates — and they lack important consumer protections.

What is a non-qualified mortgage?

A non-qualified mortgage is a type of mortgage that doesn’t conform to certain standards set by the Consumer Financial Protection Bureau (CFPB). These standards prohibit specific loan features, like balloon payments, and mandate criteria lenders must use to evaluate applicants’ finances and ability to repay. Asset-based loans and no-income loans are common examples of non-QM loans.

Non-QM lenders also tend to use manual underwriting and have more flexibility in underwriting guidelines. They’ll work with borrowers whom conventional lenders might deem too risky because of their non-salaried income or low credit scores. These loans have:

• Different income verification options: For example, instead of W-2 forms and paystubs, borrowers may be able to document their financial situation with bank or investment account statements, 1099s, receipts from rents or leases or other business receivables, among others.
• Looser debt-to-income rules: The CFPB requires QM borrowers’ debt-to-income (DTI) ratios to be no more than 43 percent. Borrowers of non-QM loans may carry higher levels of debt, often up to 50 percent of their total monthly income.
• More lenient credit restrictions: In some cases, non-QM loans don’t require a waiting period after bankruptcy or foreclosure, enabling individuals to secure a mortgage soon after these events.

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

With that flexibility comes risk — for the lender, but also for the borrower. Non-QM loans may have risky features prohibited by the CFPB, including:

• Loan terms longer than 30 years
• Interest-only payments without paying down the principal
• Balloon payment (a big lump-sum payment at the end of a loan term)
• Negative amortization, which allows your loan balance to increase over time

Additionally, QM loans are subject to the CFPB’s cap on upfront mortgage points and fees. For loans of more than $100,000, these charges can’t total more than 3 percent of the loan amount. Lenders may charge more in points and fees for non-QM loans.

A lender may also issue a non-QM loan without following the CFPB’s “ability- to-repay” rule, that is, examining these eight components of a borrower’s finances:

• Current income/assets
• Current employment status
• Monthly payment for this mortgage loan
• Monthly payment on any simultaneous loan that’s secured by the home such as a piggyback mortgage (usually taken out when a borrower doesn’t have enough cash for a down payment)
• Monthly payment for mortgage-related obligations
• Current debt obligations, alimony and child support
• Monthly debt-to-income ratio or residual income
• Credit history

Less stringent standards on non-QM loans may make it more likely for non-QM borrowers to receive a loan that they can’t truly afford.

Who can benefit from non-qualified mortgages?

While CFPB’s Qualifying Loan standards are intended to safeguard consumers, they can sometimes be exclusionary to those whose financial profiles don’t fit the norm.

Here’s who may benefit most from a non-QM loan:

• Self-employed borrowers: These borrowers generally have sporadic pay and multiple income streams, making it hard to get a qualified mortgage. Many self-employed, non-QM borrowers get bank statement loans, which are based on their cash flow and liquid assets (rather than relying on W-2s).
• Real estate investors: These are the folks who fix-and-flip homes, or who rent out and generate an income from the homes they buy, and need funding quickly. DSCR loans (short for debt service coverage ratio) and asset depletion home loans (in which you tap the equity in your primary residence to fund the purchase of another property) often accommodate this sort of borrower.
• Foreign nationals: Non-resident borrowers who want to purchase property in the U.S. might not qualify for a traditional loan because of a low or non-existent U.S. credit score. Non-QM lenders use international credit reports and letters from creditors to qualify this group for a foreign national home loan. Mitigating factors, such as a high income, robust liquid assets and a large down payment, also help foreign borrowers qualify for non-QM loans.
• Prime borrowers: Borrowers who have pristine credit but are in search of a loan with certain features, such as interest-only payments or a debt-to-income ratio limit above the standard 43 percent, are considered “prime non-QM borrowers.”
• Near or non-prime borrowers: In many cases, these are borrowers who have insufficient credit, a prior bankruptcy or distressed property sale within the last two years. Lenders tend to require more money down and may have tighter standards elsewhere to lessen the credit risk.
• Borrowers with significant assets: A type of non-QM loan, called an asset qualifier loan, is ideal for borrowers with prime credit and substantial assets. Although the borrower could buy the home outright, they may decide to finance the purchase to keep money invested elsewhere. Credit invisibles — people who have considerable assets but prefer not to use credit cards — are good candidates, too.

What are the drawbacks of a non-QM loan?

As with many financial decisions, there are some drawbacks associated with a non-QM mortgage that are important to bear in mind, including:

• Higher fees: These loans often come with higher fees that you’ll need to budget for.
• Larger down payment requirements: If you’re struggling to save for a down payment, the larger requirements for these loans could pose a challenge.
• Steeper interest rates. Non-QM 30-year fixed-rate loan rates are typically a percent or two higher than the prime 30-year fixed mortgage rate, according to Fitch Ratings.
• Riskier for the borrower. There’s a reason the CFPB frowns on features like balloon payments and interest-only repayments — they increase the likelihood of delinquency and default.
• Can be more expensive: Non-QM loans likely cost more than a traditional mortgage of comparable size and term.

Where can you get a non-QM loan?

If you’re interested in a non-QM loan, there are several places you can turn to, including:

• A&D Mortgage
• New American Funding
• Crosscountry Mortgage
• NASB (New American Savings Bank)
• American Heritage Lending

How to get a non-QM loan

While the specific process for getting a non-QM loan might vary by lender, you’ll typically have to follow these steps:

1. Determine your needs: Before you start searching for a lender, assess your situation and determine whether you would need a non-QM loan or if you might meet the eligibility requirements for a qualifying loan instead.
2. Shop for a lender: Do your research and find a couple of non-QM loan lenders to compare so you find the best one for your needs. Many mortgage brokers work with non-QM wholesale lenders, so they might be a good resource.
3. Get preapproved: Once you’ve found a lender you want to work with, submit the required information to apply for a preapproval. Many lenders allow you to do this online.
4. Complete loan underwriting. After finding a property and having your offer accepted, you’ll formally apply for the loan. The lender will then review your information more in-depth and decide whether or not to approve you for the loan. Be sure to respond to any requests from your lender at this stage promptly to avoid delays in the underwriting process.
5. Get the funding and close on the home: If you’re approved for the loan and receive the funding, you’re ready for the home closing.

FAQ

• Is a non-QM loan bad?
  

  Neither non-QM loans nor non-QM borrowers are “good” or “bad.” The loans simply offer a less regulated alternative to mainstream mortgages. In many cases, the borrowers who use non-QM loans have significant income or assets, but they don’t meet the underwriting standards for qualifying mortgages. One trade-off: Because non-QM loans are aimed at borrowers who fit underwriting profiles considered more risky by lenders, the rates tend to be higher compared to qualifying loans.

• Do banks offer non-QM loans?
  

  Some do. However, the lenders most active in the non-QM market are different from the originators most active in QM loans. As in the QM market, though, the biggest players are not banks.

• Can you refinance out of a non-QM loan?
  

  Possibly. If you get a non-QM loan because of a bankruptcy or foreclosure, you could refinance into a qualifying mortgage after those black marks fade into your past. But for many borrowers, including business owners and real estate investors, non-QM loans are the best — and perhaps only — type of mortgages that fit their financial situations.

• Are there alternatives to a non-QM loan?
  

  Not really. Non-QM loans are the alternative to qualifying loans.