Non-QM Loans: A Guide For Non-Traditional Borrowers

In a financial landscape dominated by conventional mortgages, navigating alternative options can feel daunting. However, for those with unique income situations, non-QM loans can be a breath of fresh air. While these loans may come with slightly higher costs, they provide a viable path to homeownership for a large subset of the population that is often overlooked.

What are non-QM loans?

A Non-Qualified Mortgage, or non-QM, is any home loan that doesn’t comply with the Qualified Mortgage (QM) rules set by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Act requires lenders to make a good-faith effort to determine that applicants have the ability to repay a mortgage, known as the ability-to-repay (ATR) rule.

Qualified Mortgages must not have risky loan features like negative amortization, interest-only payments, balloon payments, terms exceeding 30 years, and excessive points and fees. Moreover, they must meet at least one of the following criteria:

• The borrower’s debt-to-income (DTI) ratio must be 43% or less.
• The loan must be eligible for purchase, guarantee, or insurance by government-sponsored enterprises (GSEs), Federal Housing Administration (FHA), US Department of Veterans Affairs (VA), or the US Department of Agriculture (USDA), regardless of the DTI ratio.
• The loan must be originated by insured depositories with total assets less than $10 billion and held in a portfolio for at least 3 years.

Any mortgage that doesn’t meet this criteria is considered a non-QM or non-qualified mortgage.

Who are Non-QM loans for?

While a non-QM loan might imply high risk, it’s not necessarily the case. Non-QM loans are tailored for creditworthy borrowers who can’t qualify for traditional mortgage loan programs. These include:

• self-employed individuals,
• first-time homebuyers,
• borrowers with substantial assets but limited income,
• jumbo loan borrowers,
• and investors who do not meet the qualifications for GSE and government loans.

Non-QM loans, such as bank statement loans or debt service cover ratio loans, offer alternative ways to prove income and the ability to repay the loan, which can be beneficial for borrowers with irregular income or complex financial situations.

Understanding Non-QM Loans

Non-QM loans are a category of loans that do not meet the Consumer Financial Protection Bureau’s guidelines, including those for income verification and debt-to-income ratio. However, they are still a safe and responsible choice for many would-be homeowners.

Here is a summary of the key features for the main non-QM loans.

Bank Statement Loans

Bank Statement loans are designed for self-employed individuals who have a regular income stream but can’t provide traditional income documentation. These loans use bank statements to verify income instead of W2s or tax returns.

ITIN Non-QM Loans

ITIN Non-QM loans are designed for borrowers who do not have a Social Security number but have an Individual Taxpayer Identification Number (ITIN). They are commonly used by non-resident and resident aliens in the United States.

Asset Depletion Loans

Asset Depletion loans calculate income by dividing the borrower’s total assets by a set number of months (usually 360 months for a 30-year mortgage). These loans are great for retirees or others with substantial assets but less monthly income.

Cross-Collateralization Loans

Cross-collateralization loans allow borrowers to use the value of an existing property to secure a loan on a new property. This is beneficial for those with high equity in one property but low cash flow.

Debt Service Coverage Ratio (DSCR) Loans

DSCR loans are no-income verification loans ideal for investment properties. Instead of focusing on the borrower’s income, lenders look at the property’s income-generating potential compared to the proposed mortgage payment.

Non-Prime/Non-Agency Loans

Non-Prime or Non-Agency Loans refer to mortgage loans that do not conform to standard Agency guidelines (Fannie Mae and Freddie Mac). They are designed for borrowers with a less-than-perfect credit history or have unique circumstances.

Investor Cash Flow Loans

Investor Cash Flow Loans are a type of non-QM loan where the investment property’s rental income is used to qualify rather than the borrower’s personal income.

Foreign National Loans

Foreign National Loans are designed for non-U.S. residents seeking to buy property in the United States. They offer flexible terms and conditions to suit the specific needs of foreign nationals.

The State of Non-QM

The share of non-QM loans dipped to its lowest level of 2% in 2020 due to the pandemic, but by 2022, it nearly doubled to 4% of the first mortgage market. The reasons why non-QM loans originated in 2022 didn’t fit into the QM box were mainly due to the use of limited or alternative documentation (55%), debt-to-income (DTI) ratios above 43% (26%), and interest-only loans (23%).

It’s important to note that today’s non-QMs are generally high-quality loans, and they are vastly different and less risky than those originated before the Great Recession. For example, the average credit score of homebuyers with non-QM in 2022 was 771 compared to 776 for homebuyers with QMs, demonstrating the creditworthiness of non-QM borrowers.

Despite the higher DTI ratios, non-QMs are performing well. The serious delinquency rate for non-QM loans is just slightly higher than the rate for QM loans and significantly lower than for government loans. To counterbalance the risk of default, lenders usually set a higher interest rate on non-QM loans.