Every year, millions of borrowers who can’t get a traditional mortgage turn to a non-qualified mortgage (Non-QM) provider to purchase or refinance a home.
Yes, borrowers must still qualify for a Non-QM loan, but the criteria for applying for and obtaining these loans are different — not only from those required for a traditional mortgage, but they also vary among different types of Non-QM loans.
The most popular Non-QM loans are personal and business bank statement loans, and DSCR (Debt Service Coverage Ratio) loans.
Bank statement loans can be used to buy a primary or secondary residence, or an investment property. Loan amounts vary from one Non-QM lender to the next but can be as high as $3 million.
DSCR loans are business purpose loans used by investors to purchase a rental income-generating property. Loan amounts vary from one Non-QM lender to the next but can be as high as $2 million and certain lenders can close these loans in as little as 15 days (this can be a significant advantage if there is competition for the property).
There are other types of Non-QM mortgages such as Asset Utilization loans — a specialized product for high-net worth borrowers and those with significant assets that can be used to qualify for the loan. For this article, we’ll focus on bank statement and DSCR Non-QM loans.
Personal and business bank statement Non-QM loans.
The most popular alternative to a traditional mortgage is a bank statement loan. These loans may be ideal for self-employed borrowers who don’t receive a W2 tax form from an employer. Traditional mortgage providers use W2 forms to verify borrower income and to help determine loan affordability.
First, you need a verifiable income.
Both traditional and Non-QM mortgage lenders use a borrower’s monthly income stream to evaluate loan affordability. On a bank statement loan, in lieu of a traditional W2, Non-QM lenders use 12-24 months of a borrower’s personal or business bank statements to document income. The lender’s underwriting team will peruse these statements to determine the borrower’s regular cash flow and loan affordability.
Next, let’s talk credit score and history.
Non-QM loans are not backed by Freddie Mac and Fannie Mae – two government-sponsored enterprises that establish credit requirements for a traditional mortgage loan. Even so, Non-QM borrowers must still have credit scores that fall within a certain range. The difference is that this range is wider than for a traditional mortgage because Non-QM lenders have more flexibility in determining customer credit parameters.
For a Non-QM loan, credit scores can be as low as 620. As with a traditional mortgage, your score will influence other terms of the loan such as the interest rate and the maximum loan amount.
Your credit history will be used to determine eligibility and the terms of the mortgage. However, if you have had an issue in the past, it is not necessarily a deal breaker in Non-QM. Those with a blemished housing history, i.e. missed rent or mortgage payments, may still qualify for a Non-QM mortgage. Different providers have different ‘seasoning’ guidelines. Seasoning is the amount of time, measured in months, that a borrower has maintained a good repayment record since experiencing a credit or housing event.
Why debt-to-income ratio (DTI) is important.
Most borrowers believe that mortgage lenders rely primarily on credit scores to determine creditworthiness. In fact, debt-to-income ratio is just as important in assessing the ability to make a monthly mortgage payment.
A debt-to-income ratio is exactly that. It measures how much you owe in financial obligations every month to your income. Student loans, car loans and credit card balances are the most common forms of debt taken into consideration when calculating DTI – especially for first time home buyers. The typical allowable level of DTI by Non-QM providers is 50%.
What about a down payment for Non-QM loans?
Yes, just as with a traditional mortgage, you will need a down payment when applying for a bank statement Non-QM loan. Once again, the amount of the down payment varies depending on your qualifications.
In general, borrowers with higher credit scores of 720+ will need to put down 10% of the price of the property (meaning the Non-QM mortgage provider will finance up to 90% of the total amount) while those with scores closer to 620 will need to put down 25% (with the Non-QM lender financing up to 75% of the property’s price.)
DSCR (Debt Service Coverage Ratio) loans for property investors.
DSCR loans are a different animal altogether from bank statement and other types of Non-QM mortgages. The reason is simple – Instead of borrower income, these loans use the projected income from the property being purchased to assess repayment ability. For example, let’s say a property investor wants to purchase a two-family home. Each unit rents for $2,800 per month for a total monthly income stream of $5,600. This must cover at least 75% or ¾ of the monthly loan payment.
Credit scores and down payments for DSCR loans.
While no borrower income verification documentation such as a W2 is required, property investors applying for a DSCR loan will still need to demonstrate a certain level of creditworthiness. Most lenders require a minimum credit score of 640.
The loan-to-value (LTV) ratio on a DSCR loan can vary but typically tops out at 80%. Investors will need to make up the difference with a down payment of at least 20%.
What else do Non-QM borrowers need to know?
The Non-QM mortgage market was established to provide home loans to the millions of borrowers underserved by the traditional mortgage industry. While Non-QM providers must still lend responsibly and meet the requirements of the private investors funding or buying their loans, they have more flexibility when it comes to underwriting. Whether it’s a refinance or a home purchase, they may make common sense exceptions and allowances on a loan-by-loan basis.
The better you prepare for applying for the loan, the easier it will be for your loan officer to submit your application and the faster you’ll get a response. Start by finding an experienced Non-QM loan officer in your area before you begin looking at properties. They will help guide you through the process and can work directly with the Non-QM provider on your behalf.