If a loan doesn’t meet the Qualified Mortgage Rules, it’s considered a non-qualified mortgage. Understanding the characteristics of a non-qualified mortgage can help you decide if it’s right for you. Nowhere does it state that a non-QM loan is bad. You should just understand what it is though. You should also understand what it means for your financial future before proceeding.
What is a Non-Qualified Mortgage?
Let’s start with this. A non-qualified mortgage is not necessarily a high-risk loan. Basically, it’s a loan that doesn’t meet the Qualified Mortgage Guidelines. So let’s look at what those QM guidelines are:
- no more than 3 points charged upfront
- doesn’t exceed a 30 year term
- fully amortizes principal and interest
- doesn’t have negative amortization
- debt ratio that doesn’t exceed 43%
So as you can see a non-QM loan could simply be an interest only loan. Does this make it bad? It doesn’t. It just doesn’t meet the QM guidelines because of the risk of payment shock the borrower might experience.
Who Benefits From the Qualified Mortgage?
Both the lender and the borrower benefit from the Qualified Mortgage.
The lender benefits because they are protected against legislation should the borrower default. As long as the lender follows all QM guidelines they can’t be sued by the borrower. This includes putting forth good effort in establishing the ability to repay the loan.
The borrower, of course, benefits by securing a loan they can afford. Generally, that’s the idea whether it’s qualified or not. But, there are some extra precautions in place that safeguard borrowers with the QM loan. This doesn’t mean, though, that non-qualified mortgages automatically put a borrower at risk.
The Characteristics of a Non-Qualified Loan
So now let’s look at what the characteristics of a non-qualified loan look like:
- Interest only loans – Despite the housing crisis being blamed on loans like the interest only loan, they still exist. The primary borrowers with this type of loan are the wealthy investors. They often flip homes and don’t need to worry about paying down the principal. They take the interest only loan to help them have cash flow while they fix the home up. Once they sell it, they pay the loan off.
- Stated income loans – This is another type of loan that many put the blame for the housing crisis on. Today’s stated income loans aren’t the same, though. They are more like an alternative documentation loan. Rather than “stating” income, borrowers provide different documentation. For example, rather than paystubs and W-2s, they might provide bank statements. The income is verified, just in a different way.
- Verified asset – Borrowers that don’t have a current income but have enough assets to cover the mortgage payments may use the Verified Asset program. This is a non-qualified program since the lender doesn’t directly verify income.
The basic characteristics of a non-qualified loan are those that make it a risky loan. A few other examples include loans given to borrowers who recently had a bankruptcy or foreclosure. Lenders that allow a shorter waiting period than the standard FHA, VA, and conventional guidelines fall under the non-QM category.
The largest category of borrowers that take out a non-qualified mortgage, however, are the self-employed borrowers. These borrowers may not have the paperwork showing the income they actually make. Or they make less on paper than they truly bring in. The most common issue is the borrower that is self-employed for less than 2 years. Most FHA and conventional lenders won’t be able to accept this income. A non-QM lender would be able to, though.
You could call these loans “subprime,” but they really aren’t. They are just loans provided by private lenders that choose to carry the loans in their own portfolio.
All Loans Must Meet the Ability-to-Repay Rules
No matter what type of loan you take out, it must meet the ability-to-repay rules. Basically, this means the lender made a good faith effort in determining that you can afford the loan.
The method the lender uses depends on the lender’s own requirements. In a perfect world, this means documenting income and assets. But when that’s not the case, the lender must use adequate effort to make sure the loan is affordable. In addition, the borrower must make sure the fully amortized payment is affordable. This is the case in interest only loans as well as adjustable rate loans. Lenders can’t use the teaser rate to determine if a borrower can afford the loan.
Maximizing the efforts to make sure borrowers can afford a loan can help minimize default. As you can see, the characteristics of a non-qualified mortgage aren’t bad characteristics. They are just alternate ways to help borrowers get a loan that they can afford.