Non-QM Loans: When Are They a Good Idea?
If you’re financially stable but having trouble qualifying for a mortgage with a standard loan program, a non-QM loan may be worth considering. Non-QM is short for “nonqualified mortgage,” a name given to loans that don’t follow the consumer protection rules that traditional (“qualified”) loans have to meet.
Non-QM loans can be a good choice for borrowers who need more flexibility in qualification requirements — for instance, borrowers who don’t have a credit score, are self-employed or have large assets but little income. However, non-QM loans are typically more expensive and may come with unusual features that most lenders wouldn’t allow.
What are non-QM loans?
Non-QM loans are mortgages that don’t meet the Consumer Financial Protection Bureau’s (CFPB) requirements to be considered qualified mortgages. (Traditional home loans, including conventional and government-backed loans, are qualified mortgages.)
Existing outside of these rules gives non-QM lenders a lot of freedom, both in who they can approve for a loan and in the features of those loans. For borrowers, this freedom cuts both ways: It can help you qualify for a loan, but it can also mean that the loan you end up with is more expensive and more likely to cause you financial strain.
Common features of non-QM loans
Non-QM loans can offer flexibility when it comes to qualifying with:
- Alternative income documentation. A non-QM lender can choose to use bank statements to calculate the income that will qualify for your loan. Traditional mortgage lenders require pay stubs, tax returns and W-2s.
- Recent negative credit events. Non-QM lenders often offer programs that allow you to borrow within days of a major recent credit event, like a bankruptcy or foreclosure. This can mean you won’t have to wait the two to seven years required by qualified mortgage loan programs.
- Higher debt allowances. If you have a debt-to-income (DTI) ratio over 43%, you typically can’t qualify for a traditional mortgage without compensating factors. Compensating factors are strong points in your financial profile that can help lenders feel comfortable lending to you, even if you don’t meet the typical guidelines. For example, an extremely low DTI ratio, a large amount of cash in savings or a very large down payment. Non-QM loans don’t have the same restriction.
Non-QM loans may also come with unique features like:
→ Interest-only payments. Lenders that offer an interest-only option don’t require you to pay down any of your loan balance for the first several years of the loan term. Instead, you just pay the interest that accrues each month. The downside is that, even after making steady payments for years, you’ll still have little equity and a huge loan balance.
→ Negative amortization. Some non-QM lenders may allow you to make payments for less than the interest they’re charging you each month. As a result, your loan balance grows over time even though you’re making payments (this is called “negative amortization”).
→ Balloon payments. You’ll make a larger-than-usual payment at the end of the loan term if your non-QM loan has a balloon payment. Without a solid plan in place, this huge outstanding payment can quickly become overwhelming.
→ Longer loan term. You may find a non-QM lender that offers terms longer than 30 years. It’s not usually possible to take out a qualified mortgage with a loan term that long, though sometimes a loan modification may bump up a qualified mortgage’s term over 30 years.
→ Higher-priced loans with upfront points and fees. To offset the higher risk lenders take in issuing a non-QM loan, you’ll likely pay a higher mortgage rate, annual percentage rate (APR) and even upfront fees and mortgage points that aren’t permitted on qualified loans.
Understanding the “ability to repay” rule
Both qualified and nonqualified mortgages must meet the CFPB’s “ability to repay” rule, which requires that lenders vet your finances and set loan terms that you’re likely to pay back. The difference is in how they go about evaluating this.
The best way to make sure you’re not getting into a loan that will cause you financial distress down the road is to make sure you understand exactly what you’re committing to. Go through your loan documents with a fine-toothed comb, calculate the highest possible mortgage payment for your budget and create a solid plan for how you’ll repay the loan.
Need help? The U.S. Department of Housing and Urban Development (HUD) offers free housing counseling to anyone in need. Find a HUD-approved housing counselor online or call 800-569-4287.
Overview: Qualified vs. nonqualified mortgages
| Loan feature | Qualified mortgage | Non-QM loan |
|---|---|---|
| Debt-to-income (DTI) ratio | Typically capped at 41% to 45% | Not required on some programs |
| Income documentation | Tax documents | May allow bank statements instead |
| Waiting period after bankruptcy or foreclosure | Two to seven years | One day |
| Assets can count as income (“asset depletion”) | Not allowed | May be allowed |
| Down payment | As low as 0% to 3.5%, but 14% on average | Typically 10% to 25% or more |
| Number of financed properties allowed | Up to 10 | No limit |
Who are non-QM loans good for?
Non-QM loans are handy for people who are financially sound, but have been denied a home loan under traditional mortgage standards. In many cases, a nonqualified mortgage provides a temporary solution until the borrower can meet regular mortgage guidelines and refinance to a qualified loan.
Non-QM lenders offer options tailored to:
- Self-employed borrowers. Self-employed income can be hard to prove, so non-QM lenders offer loans based on your bank statements, rather than tax paperwork. The lender typically looks at the deposits you’ve made over a 12- to 24-month period as a way to determine your qualifying income.
- Borrowers with damaged credit histories. You may be eligible for a non-QM loan one day after completing a bankruptcy or foreclosure. You’ll typically need to wait two to seven years after a significant credit event for standard loan programs.
- Borrowers who want an interest-only payment option. Sporadic income-earners may benefit from an interest-only loan that allows for a lower payment option during times of the year when they earn less. One caveat: Your payment could increase after the interest-only period ends, making the loan harder to repay.
- High-net-worth borrowers. If you have a lot of wealth, you may not necessarily have a lot of monthly income. That’s why some non-QM lenders allow you to use an account with a large cash balance as your qualifying income. For example, a lender might consider your $200,000 savings balance as equivalent to $833.33 of extra monthly income for the purposes of qualifying for a mortgage. This is known as an “asset depletion” loan.
- Borrowers investing in multiple rental units. Non-QM loans may be a good choice for investors who own more than 10 financed investment properties, which is the limit for most conventional lenders. Other non-QM lenders offer special loans, known as “debt-service coverage ratio loans,” for real estate investors. If the rent on the new property covers the monthly payment, you don’t need other income to qualify.
- Foreign nationals. A foreign national is a citizen of another country who lives in the U.S. for brief periods of work or vacation. Non-QM loans for foreign nationals may not require proof of U.S. income, credit or a Social Security number.
Learn more about refinancing your mortgage after bankruptcy.Pros and cons of a non-QM loan
| Pros | Cons |
|---|---|
| You can use alternative documentation to verify income More relaxed credit requirements, including options for borrowers with no credit or those with a recent bankruptcy or foreclosure Foreign nationals can qualify No limit on how many financed properties you can own | Down payment requirements are typically higher Interest rates and fees may be more expensive than standard loans Risky features may increase your risk of mortgage default Not all lenders offer non-QM loans, which makes them harder to find |
How do I get a non-QM loan?
The process to get a non-QM loan is very similar to the traditional mortgage loan process. You’ll still need to submit an application and provide documentation to support it. The main difference is in what types of paperwork your lender will need, and the requirements you’ll have to meet.
It’s essential to shop around before choosing a lender, whether you’re searching for a non-QM loan or a traditional mortgage. Fewer lenders offer non-QM loans, but you only need three to five in order to compare loan offers and save money. This simple step can get you the best rate and save you tens of thousands of dollars, according to a LendingTree study.
Ready to research lenders? Our list of the best bad credit mortgage lenders includes several who offer non-QM loans.
Alternatives to a non-QM loan
If non-QM loans are too expensive or risky for you, you may want to explore one of these alternatives:
| If you … | Alternative to consider |
|---|---|
| Have a recent bankruptcy or foreclosure in your credit history | You can knock up to five years off the usual waiting period for a qualified mortgage if you can prove “extenuating circumstances” played a part in your bankruptcy or foreclosure. These can include unemployment, illness or a death in the family. |
| Have a high DTI ratio | A debt consolidation loan can help you pay down debt more effectively. This alone will lower your DTI ratio but, paired with any increase to your income, you can more quickly get your DTI under the 41% to 45% threshold needed for a qualified mortgage. |
| Want a custom loan repayment term for your mortgage refinance | A refinance lets you restart the clock on a new loan term. Paired with the custom loan terms some mortgage lenders offer, these options ensure you aren’t stuck with the standard 15- or 30-year timelines — you can time your refinance loan’s payoff precisely using any loan term between eight and 29 years. |
| Have no credit | Even with no credit score, you may still get approved for a traditional home loan.
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