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- A non-qualifying, or non-QM, loan doesn't meet the Consumer Financial Protection Bureau's requirements for qualified mortgages.
- Those with unusual financial situations or rocky credit histories can use a non-QM loan to purchase a home.
- They're typically significantly more expensive than traditional mortgages and come with a higher risk of default.
In the wake of the Great Recession, the mortgage industry was forced to tighten its lending standards to prevent another subprime mortgage crisis.
It's generally been a positive development that lenders are held to higher standards when it comes to ensuring their borrowers can afford the mortgages they're getting. But the more stringent guidelines mean that some borrowers — such as self-employed individuals or gig workers — have trouble meeting the requirements to qualify for a traditional, conforming mortgage even though they can afford to take on the loan.
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- Paying a 25% higher down payment would save you $8,916.08 on interest charges
- Lowering the interest rate by 1% would save you $51,562.03
- Paying an additional $500 each month would reduce the loan length by 146 months
Non-conforming loans, often referred to as non-QM loans, are a type of mortgage that some lenders offer to help these types of borrowers qualify for a loan. But they're often expensive, both up front and over the long term.
What are non-QM loans?
To understand what a non-QM loan is, you need to know what a qualified mortgage is. Qualified mortgages are a category of mortgage created by the Consumer Financial Protection Bureau (CFPB) that refers to loans that have qualities that make borrowers less likely to default on them.
These qualities include debt-to-income ratios below a certain threshold and reasonable costs for points and fees. Qualified mortgage lenders must also use specific types of mortgage documentation to verify your income and ensure you have the ability to repay the loan.
"Non-QM loans are a solid alternative to conventional financing, but they do come at a price," says Joshua Massieh, CEO of Pacwest Funding in San Diego and contributor to The Trading Fraternity channel on Youtube. "There are several types of home loans that fit in the non-QM bubble, and typically they are designed for individuals who are self-employed or who simply don't fit in the conventional loan box."
Some non-QM loans allow for alternative methods of approval, while others are aimed at those who have negative events on their credit reports that prevent them from qualifying for a regular mortgage.
Types of non-QM loans
There are several types of non-QM loans. These include:
Interest-only loans
Interest-only loans allow you to pay only interest on your mortgage for a certain period of time. Then, you'll start making principal and interest payments once that period expires.
Keep in mind that these are usually variable-rate loans, so your interest rate can change over time.
Asset-based loans
Asset-based loans are mortgages that aren't based on your income, but instead, on your assets — the properties, bank accounts, and other valuables you own. These can often be good for business owners or real estate investors.
Limited or no income verification loans
WIth these non-QM loans, lenders either verify your income in alternative ways — such as through bank statements — or they don't factor it in at all. These can be helpful if you're buying a rental property or fix-and-flip, which will produce money for payments after closing.
Jumbo loans
Jumbo loans are mortgages that go above the conforming loan limits. These can sometimes go well into the multi-million range. You'd use this when buying a higher-priced house or shopping in a more expensive housing market.
Benefits of non-QM loans
Non-QM loans aren't right for everyone, but they are advantageous to certain home buyers. They offer:
Flexible underwriting standards
Non-QM loans don't adhere to the strict credit, debt-to-income ratio, down payment, and other requirements that come with QM loans. This means you may be able to qualify for a non-QM loan, even when a QM loan is out of the question.
Lenders may also allow you to borrow more than is offered with traditional mortgages.
Alternative income verification
Some non-QM loans allow borrowers to qualify without tax returns and W-2s — the traditional income verification you'd need for a mortgage.
A bank statement loan is one example. With this type of mortgage, the borrower provides bank statements to show proof of income, rather than the standard tax documents lenders use on qualified mortgages.
"A bank statement loan might be an advantage if the borrower's tax returns don't adequately reflect their income," says Suzanne Ross, director of mortgage product at Ocrolus. "For example, a borrower whose tax returns reflect lower income than was actually made due to business expenses and deductions taken."
Non-QM loans may also be beneficial for investors who want to use the cash flow from the properties they're purchasing to qualify.
Options for borrowers with unique financial situations
For borrowers who can afford a mortgage but have an unusual financial situation that makes getting a qualified mortgage difficult, a non-QM loan can make homeownership possible.
"In some cases, this is a borrower with a short credit history or a job in the gig economy whose income comes from Paypal, Venmo, and other sources not always associated with regular pay stubs," Ross says.
Some lenders also offer non-QM loans to borrowers who have recent bankruptcies, foreclosures, or other negative events on their credit reports. For example, you'll typically need to wait seven years after a foreclosure to qualify for a traditional loan, but some non-QM loans may not have any waiting period at all.
Eligibility requirements
Qualifying for a non-QM loan can sometimes be easier than with a traditional mortgage. The exact requirements you'll need to meet depend on your lender, but here's the general gist of non-QM loan eligibility:
Credit score considerations
You'll usually need at least a 620 credit score to qualify for a non-QM loan, but this isn't set in stone. Some lenders may require lower or higher than this.
Income and employment verification
This is where non-QM loans usually stand out. You may be able to qualify with no income or employment verification at all or, depending on your lender, you can use bank statements, asset statements, or estimates of future rental income, among other documents.
Asset requirements
You'll usually need a larger down payment with a non-QM loan, so lenders will want to see asset statements that prove you have the cash to cover it. They also may want you to have more cash in reserves — especially if they're not verifying your income or your income fluctuates.
How to apply for a non-QM loan
To apply for a non-QM loan, you'll need to:
Find the right lender
Non-QM loans aren't a super popular type of mortgage, so you'll need to look around to find a lender. Your best is typically a smaller lender, an online mortgage company, or a lender that specializes in more unique borrowers — like investors or those who are self-employed. New American Funding and Griffin Funding are two examples of lenders that offer these loans.
Submit the required documentation
This will vary based on the type of non-QM loan you're getting and your lender. It may include bank statements, profit and loss statements for your business, proof of past rental income, and more. Ask your loan officer for a full list of documents you might need.
Application process
The application process for a non-QM loan looks much like any mortgage loan, except you may need to submit additional or alternative documentation. You'll apply for the loan, hand over your documents, wait for an appraisal, pay your closing costs, and close on the loan.
Comparing non-QM loans with QM loans
The alternative to a non-QM loan is a QM loan. These must meet certain requirements set by the government. Here's what to know about non-QM loans vs. QM loans.
Key differences
QM loans are usually stricter on credit score and DTI, and they have lower loan caps, too. They also can't have risky features like balloon or interest-only payments, and there are rules for how lenders must analyze your income and financial qualifications.
Non-QM loans come with more leeway. Since they aren't subject to the QM rules set by the government, lenders have more freedom in who they can loan money to.
Pros and cons of non-QM loans
Non-QM loans can be useful if you don't qualify for another type of mortgage, but they're often expensive and can be risky.
Conventional, conforming loans (QM loans) are typically more affordable than non-QM loans, though. So if you're able to qualify for one, you should get a conforming loan rather than a non-QM loan.
"Typically, conventional loans come with lower down payment requirements, the interest rates are typically a full 2 - 3% lower than a non-QM loan, and a conventional loan will cost you less to obtain," Massieh says.
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Non-QM loans are more expensive than traditional mortgages, both up front and in the long term. You'll likely pay higher closing costs due to the increased cost of points and fees that often come with a non-QM mortgage, and you'll probably have a significantly higher rate than traditional mortgage rates.
You should also consider the risk that you won't be able to repay the loan. If your finances are shaky, or if the loan has expensive features, you could end up defaulting.
Non-QM mortgage FAQs
A non-QM loan is a mortgage that doesn't meet the Qualified Mortgage (QM) guidelines set by the Consumer Financial Protection Bureau (CFPB).
Borrowers with unique financial situations, such as self-employed individuals, real estate investors, or those with irregular income, can benefit from non-QM loans.
Common types include interest-only loans, asset-based loans, limited or no income verification loans, and jumbo loans.
Qualifying involves meeting specific credit, income, and asset requirements set by the lender, which may be more flexible than QM loan criteria.
The benefits of non-QM loans include flexible underwriting and alternative income verification; cons include potentially higher interest rates and a larger down payment.
