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For borrowers who can afford a mortgage but have had trouble getting a qualified mortgage, a non-QM loan can make homeownership possible.
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A non-qualifying, or non-QM, loan doesn’t meet the Consumer Financial Protection Bureau’s requirements for qualified mortgages.
These mortgages can help those with unusual financial situations or rocky credit histories purchase a home.
But 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.
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 is a non-QM loan?
A non-QM loan is a mortgage that doesn’t meet the requirements to be considered a qualified mortgage.
What is a qualified mortgage?
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 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.
Who are non-QM loans for?
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,” says Suzanne Ross, director of mortgage product at Ocrolus.
One popular type of non-QM loan is a bank statement loan. 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,” Ross says. “For example, a borrower whose tax returns reflect lower income than was actually made due to business expenses and deductions taken.”
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.
Non-QM loans may also be beneficial for investors who want to use the cash flow from the properties they’re purchasing to qualify.
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.
ProsCons
Can help borrowers get a mortgage if they otherwise don’t qualify for one
Can use alternative means, such as bank statements, to show income
Possible to qualify even if you have recent negative events on your credit report
Provide more flexible terms
Higher interest ratesPoints and lender fees are often more expensiveYou may need a larger down paymentNot widely availableHigher risk of default
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 you’d get with a traditional mortgage.
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.
Is a non-QM loan a conventional loan?
Conventional loans are mortgages that aren’t backed by a government agency. Non-QM loans technically fit this definition, but when most people talk about conventional loans, they’re referring to conforming loans. Conforming loans are a type of conventional loan that meet Fannie Mae or Freddie Mac guidelines.
Conventional, conforming loans are typically more affordable than non-QM loans. 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.
Even if you think you might not be able to qualify for a conforming loan, it’s worth it to talk to a lender and see what your options are. Being self-employed, for example, doesn’t automatically prevent you from getting a conforming loan.
“Many borrowers are eligible for conventional financing, even with inconsistent or non-traditional income,” Ross says.
Are non-QM loans safe?
Some non-QM loans may come with certain risky features that aren’t allowed on qualified mortgages. According to the CFPB, this could include:
Interest-only periods, during which the borrower only pays interest, meaning they aren’t paying down their loan principal.Negative amortization, where the loan principal increases over time. This happens when your payments aren’t enough to cover the interest on the loan, so it gets added to the principal.Balloon payments, which are payments owed at the end of the loan that are much larger than your regular monthly payment.Terms longer than 30 years
If you’re thinking about getting a non-QM loan, be sure you understand all of the terms that come with it and that you can afford it, both now and over the life of the loan.