If you’ve had any reason to pay attention to the mortgage world over the past few years, you may have heard or read the term Non-QM. Short for Non-Qualified Mortgage, Non-QM loans have been around for almost a decade, but they’ve only recently come into the mortgage spotlight.
What is a QM loan?
The Ability-to-Repay Rule (ATR Rule) requires a creditor to make a good faith, reasonable determination of a consumer’s ability to repay a loan based on common underwriting factors. A Qualified Mortgage is a loan that meets certain criteria and therefore provides a presumption of compliance with the ATR Rule. Generally, the requirements for a Qualified Mortgage include: (1) a prohibition on certain features, such as an interest-only period; (2) a limit on the annual percentage rate of the loan; (3) a limit on the amount of certain up-front points and fees; and (4) a verification of income or assets and debts. Even if a loan is not a Qualified Mortgage, it can still be an appropriate loan and comply with the ATR Rule.
What is a Non-QM loan?
As the term non-qualified implies, a Non-QM mortgage does not meet the definition of a Qualified Mortgage; a Non-QM loan is not qualified against criteria set by the traditional, government-backed mortgage apparatus.
While a Non-QM mortgage must comply with the ATR Rule, providers can ‘open the box’ on certain loan features, limits on APR, limits on up-front points and fees, and income verification methods.
The difference between qualifying for a QM vs. Non-QM Mortgage
One of the primary differences between the criteria required for qualifying for a QM vs. Non-QM loan pertains to income verification.
A traditional, government-backed loan typically requires a W2 or income tax returns for verifying the applicant’s employment status and income.
However, there are tens of millions of people in the U.S. workforce who don’t receive a W2 because they are self-employed. Think freelancers, contract workers, even business owners (who ironically provide W2s to their employees but don’t receive one themselves). These are the types of borrowers who can turn to the Non-QM market when buying a home. Non-QM lenders have the flexibility to use alternative methods to document and verify a borrower’s employment status and income. The most popular is a bank statement program that allows borrowers to document their income through the use of 12 or24 months of business or personal bank statements.
QM vs. Non-QM: How credit history and score come into play.
The traditional, government-backed mortgage market sets very specific and narrow ranges for borrower credit scores. If a borrower has had a recent ‘credit event,’ such as late payments on a mortgage or a bankruptcy, they may have difficulty qualifying for a traditional mortgage.
Non-QM providers, while always complying with responsible lending guidelines, have the flexibility to provide loans to those with thin credit (not enough history) or those who have experienced a credit event. The amount and terms of the loan are considered and adjusted on a case-by-case basis.
What about a down payment?
Both Non-QM and QM loans require a down payment. However, Non-QM lenders can be more flexible in terms of the amount of the down payment, depending primarily on the size of the loan and the borrower’s credit score. For a bank statement loan, the down payment can be as low as 10%. This means the Loan-to-Value ratio (LTV) is 90%— in other words, the loan can cover 90% of the total value of the property. If the down payment is 15%, the LTV is therefore 85%. Depending on the terms of a loan, Non-QM providers may also require that a borrower hold a certain amount of cash reserves to secure it.
Another difference? Non-QM offers more products.
Another type of loan that is seeing a rise in popularity is the 40-year Interest Only (I/O) mortgage. In this case, borrowers pay only the interest on the mortgage for the first 10 years. After that, the monthly payments cover both interest and principal until the mortgage is paid in full.
Ready to learn more about Non-QM loans?
Although you now have a basic understanding of the differences between QM and Non-QM mortgages, there is more to learn. Especially if you think a Non-QM loan may be right for your borrowers. There are two origination channels for Non-QM loans: banks and non-bank lenders who originate and then sell their Non-QM loans to the private mortgage market as well as independent Non-QM brokers who partner with Non-QM lenders. While the loans products themselves are pretty much the same across both channels, the service quality can vary. Be sure to choose a partner who responds quickly, takes the time to explain all of your options and is ready to work closely with you to get the loan your borrowers need.