Non-Qualified Loan

10 Things You Need To Know About Interest-Only Loans

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For borrowers who are not fit for a qualified mortgage, they usually look into Non-Qualified Mortgage (Non-QM) Loans. And since these are unique loans for unique situations, it pays to get to know how each one works.

Perhaps one of the most common non-QM loans in the market is the interest-only loan. True to its term, this loan lets you pay off just its interest for a set period. But there’s more to interest-only loans than that. Here are a few facts about it:

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1. Lenders usually let borrowers pay the interest amount first generally between five and seven years.

2. After the interest-only period ends, you can either start paying off the principal and the interest, refinance the loan, or make a balloon payment.

3. If you choose to refinance after the interest-only period, you can refinance to the same type of loan or change it into a more stable loan.

4. Because it’s “interest-only,” the loans start out at very low rates during the initial period.

5. The initial low rates and payments make room for you to make investments, grow your extra money that could help make it easier to pay the principal once the interest-only period expires.

6. Interest-only loans could also allow a borrower to qualify for a larger amount on his/her second loan.

7. Big banks offer interest-only loans. To those who are interested, established banks like the Bank of America or Chase have this type of loan available.

8. One of its drawbacks is that a borrower might not be able to afford to pay the principal when the loan term is done.

9. Another thing is that if you’re looking to build equity with the home you purchased, the standard term period for interest-only loans might not be enough to grow your home’s value.

10. If you think you won’t reside in the property longer than the loan term, selling the house before the Interest-only period would end is possible.

In the end, interest-only loans must be carried out by interested home buyers who know how to handle this kind of loan and the risks that go with it. It also helps to ask from different lenders shop for different offers so that you can compare and see what would really work for you.

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On Neg Am Loans, and its Pros and Cons

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On Neg Am Loans and its Pros and Cons

One type of Non-qualified Mortgage Loan (or a Non-QM Loan) is the Neg Am Mortgage Loan. In a Neg Am loan, you are not required to pay the monthly interest of the loan. You are only to make minimum payments in a specified number of payments periods.

Amortization is the process of paying off borrowed financing, say a mortgage loan, on scheduled payments over a specified period of time. Each time a borrower pays, a part of it covers the monthly interest, the remaining balance goes towards the principal.

By the end of the loan term, the principal loaned amount and the total interest are paid off completely.

Neg Am stands for negative amortization. It is also known as graduated payment or deferred interest. Because you are not required to pay any amount on the monthly interest, this interest (or whatever interest is left for that month) will rollover to the next month. The unpaid amount will be added back to the loan balance and the loan’s interest rate will apply towards this new loan balance.

What happens in a Neg Am Mortgage Loan?

For Instance, In May, Sam’s remaining principal balance is at $90,000. The annual interest rate of the loan in 6%.

0.06 (interest rate) ÷ 12 (months) x $90,000 (principal balance) = $450 (due for May)

Sam is allowed to makes minimum payments of $400 for a specified period of time. And if Sam pays $400 on the current month’s due, that sets her back $50.

$450 (due for May) – $400 (minimum payment required) = $50 (deferred amount)

The deferred amount will be added to the remaining principal balance, bringing it to $90,050 in total. In June, the computation will be based on the new principal balance. As this continues each month, the principal balance also grows bigger.

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Pros

What good can someone get from a Neg Am mortgage loan?

This loan product is good for those borrowers who intend to take advantage of the low monthly payments and use their remaining money as investment. If the investment pays much higher than the mortgage loan’s interest rate, this can cover the increasing principal balance and have more left for their savings accounts.

The Neg Am is popular with those who are not staying in the property for a long time and are planning to sell it shortly after they have purchased it.

Cons

The risk of the loan becoming uncontrollable is high. If the principal loan amount is not reduced during the specified period where you are only to make minimum payments, you will end up owing much more than the what you originally owe.

And when this specified “negative amortization” is over, you end up with such a huge amount to pay off. This may cause you to default on the loan and risk the property into foreclosure.

A Neg Am mortgage loan is not intended for everyone. If you can very well afford to get a traditional loan, might as well take that opportunity. If you think that this loan product fits your financing needs, do not hesitate to talk to a lender or a loan professional. An expert’s advice can help you make better decisions.

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Non-Qualified Mortgage Loan Programs

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Credit issues, low income, high debt, and little to no assets make it difficult to get a conforming loan or even a loan from the FHA or VA today. Because of the new qualified mortgage guidelines, lenders have to be very careful in who they lend money to or they run the risk of being sued by borrowers that default down the road. This is not to say that every borrower that does not meet the stringent qualified mortgage guidelines is a high risk however. The guidelines set forth by the Dodd-Frank Act make it difficult for anyone with unique circumstances to get a loan. The gist of the QM Guidelines is as follows:

  • No debt ratios over 43%
  • No fees in excess of 3% of the loan amount
  • No risky loan terms (balloon, interest only or negative amortization)
  • No excessively long loan terms (more than 30 years)

These guidelines put some borrowers at a disadvantage. Even if they have the ability to afford a loan, they are considered non-qualified if they have a high debt ratio, for example. For some people that high debt ratio is not a big deal because of the amount of assets they hold or they amount of their income is excessively high. For others, credit issues may have made them look risky, which makes lenders want to charge them a higher interest rate or higher fees, putting them over the 3% threshold. The credit issues may be a thing of the past, but because they are there, they play a role in the level of risk a borrower possesses, requiring the lender to charge more fees or a higher interest rate to make up for the risk.

Types of Non-Qualified Mortgage Products

There are lenders all over the country offering a variety of non-qualified mortgage products. What one lender offers, the next one may not. It depends on the portfolio of each lender as well as their amount of capital. If they have enough to gauge against the risk of a non-qualified mortgage, they may offer products that allow a 50% debt ratio or a low credit score in exchange for higher fees. The types of products offered differ greatly, but some of the constants that any lender requires include:

  • Owner occupancy
  • 0 x 30 late payments in the last 12 months on housing history
  • 1 x 30 late payments in the last 12 months in non-housing history
  • Letter of explanation for any credit issues (one-time issues such as bankruptcies or foreclosures)
  • Low LTVs, typically less than 80%, but sometimes even lower
  • Adequate assets to serve as reserves for 6 to 12 months

These are just a sampling of what lenders require in order to think about providing a non-qualified loan to a borrower. Lenders understand that the economy took a turn for the worse and millions of people have had to rethink their financial strategy including the need to become self-employed for many borrowers. Giving up a home or claiming bankruptcy is no longer looked upon as a negative circumstance as long as borrowers use it as a learning curve. If they can prove that they learned a lesson and have become more financially responsible, there are typically non-qualified mortgage products available for them.

The Common Denominator

The one thing that all lenders will have in common no matter what their guidelines are is the need to fully evaluate every loan file. They cannot provide loans like the NINJA that was around in previous years, requiring little to no verification of any income, assets, or jobs. Everything must be fully verified today in order for a loan to go through. What may differ for a non-qualified mortgage is the type of income used to qualify. For example – if you are self-employed and have only been self-employed for one year, a qualified lender will not approve you, but a non-qualified lender may have a program for your situation.

The need to verify every detail of the loan file is in place because of the Ability to Repay Rule, which is a requirement for every loan. What is negotiable is the need for it to be a qualified or non-qualified mortgage. Lenders willing to take the risk and offer non-qualified mortgage products are not guaranteed against the risk of borrowers suing them if they become unable to afford the loan. Many lenders are able to offset that risk with qualified mortgages in their portfolio, putting a little risk in each basket, allowing for diversification and plenty of profits in the end.

Specific Product Types

Every lender has their own niche for non-qualified borrowers. For example, some banks offer programs for the self-employed; retired; and real estate investors. Other lenders offer programs for those with a bankruptcy or foreclosure in their recent past or those with a higher than average debt ratio. The lenders recognize the worthiness of these borrowers and are not letting one hiccup get in the way of these potential borrowers becoming homeowners.

Careful Underwriting Procedures

Applying for non-qualified mortgage products does not mean you will not undergo a rigorous underwriting process. You will still go through the same verifications you would go through for any other type of loan. The lender needs to prove beyond a reasonable doubt that you can afford the loan comfortably whether by verifying your income, assets, or both. They need to prove that your credit blemishes are in the past and that you have caught up and are ready to take on a new liability. Without careful underwriting procedures, lenders are putting themselves at risk for lawsuits, which is something they obviously want to avoid.

Non-qualified mortgage products are available; you just have to find them. Remember that every lender has a different niche so make sure to shop around with lenders that cater to your demographic, whether you are self-employed; retired; have a low credit score; have a history of BKs or foreclosures; or have a high debt ratio. Unless you cannot prove that you have bounced back from your financial hiccups, there is likely a loan out there for you that will not cause you to pay ridiculously high interest rates and fees, making the loan unaffordable after all.

Credit Score Needed to Qualify for a Non-Qualified Mortgage

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Every mortgage has a minimum credit score parameter, but it is not always easy to figure them out. Yes, Fannie Mae, Freddie Mac, FHA, and VA loans all have posted minimum scores, but that does not mean each lender abides by those rules. They cannot go lower than the posted score, but they can require higher minimum scores if they so choose or if the investor requires them to or they will not purchase the loan. Non-QM loans, on the other hand, are a bit different – there is no set minimum credit score by any agency as they are non-qualified loans. This means the credit score minimums are dependent upon the lenders themselves and possibly the investors, if there are any purchasing the loans on the secondary market.

Qualified for a Non-QM Loan? Find Out»

If you are trying to obtain a non-QM loan, it means you have some type of factor that disqualifies you for a QM loan. Whether it is the fact that you have a debt-ratio higher than 43%; your income is not consistent so cannot be verified; or the lender needs to charge you more than 3% of your mortgage amount in fees, you are not qualified for a standard loan type. This means you will have to shop around with a variety of lenders as each one is willing to take on different risks. You can do this in several ways:

  • Call around to various lenders explaining your situation, such as you are self-employed and do not have adequate income reporting on your tax returns or you have a debt-ratio exceeding 43%. Each lender can tell you if your situation is one they would entertain before you apply.
  • Apply with several lenders within a short period of time and see who provides you with not only an approval, but also the best terms. If you apply for a mortgage with several lenders within a few weeks your credit score will not be hit for each inquiry – it gets hit only once.

Every lender operates differently – some keep the loans on their own books, so they have to determine what type of risk they can take. This depends on the portfolio already in existence and how you make it better or worse. Other lenders sell their loans to investors, which will have the final say in what they will or will not purchase. This is why there is not a set minimum credit score for non-QM loans – every lender will differ and they may even make stipulations up as they go depending on the circumstances each loan provides them with upon application.

How Non-QM Lenders Make up for Lower Credit Scores

If the reason you cannot obtain a QM loan is because your credit score is “low”, you will have to make up for the risk in fees. This is how lenders back themselves up, so to speak. They charge you more for the loan up front. This way, in the event that you default on your loan, they still made more money up front than they would have if you were a QM borrower. Of course, this does not mean they are going to lend to just anyone because they know they can charge more than the standard 3% in fees – they still have to make sure your risk is one they can handle as they want to do whatever they can to ensure that their borrowers do not default.

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Ability to Repay

The Ability-to-Repay Rule is the easiest ways for lenders to determine if your loan is worth taking on despite the fact that it will not be considered qualified. Because it is non-qualified, it leaves the lender open to the risk of borrowers suing them if they are unable to afford the loan down the road. The Ability-to-Repay Rule, however, backs the lender up slightly. This rule ensures that every borrower shows ample evidence that he can afford the loan including its higher interest rate and/or fees. The Ability-to-Repay Rule looks at the following:

  • Income
  • Assets
  • Credit history
  • Employment
  • Debt-to-income ratio

What this means is that the lender did its due diligence determining whether or not you can afford the loan. For example, if they take your loan despite the fact that your self-employment started just one year ago, they have to prove that you can show the income, reserves, responsible credit history, and manageable debt ratio. Typically a compensating factor for self-employed borrowers is adequate reserves as this offsets the fact that your income is not quite regular or looks to be that way based on your latest tax returns.

The Ability to Repay Rule is a way to keep lenders accountable for the loans they are providing borrowers without getting greedy. If a lender cannot prove beyond a reasonable doubt that a borrower can make his mortgage payments with or without self-employed income, for example, then he is not considered a good risk, even for non-QM loans.

Overall, lenders look at your entire loan profile, not just your credit score. This should be encouraging for borrowers that have a slightly lower credit score, yet have compensating factors. Even if Fannie Mae’s Desktop Underwriting program turns you away, it does not leave you without the ability to get a loan. Finding lenders that offer non-QM loans is not as difficult as it once was a few years past; more and more lenders offer them, it just depends on the level of risk they are willing to take. Remember, every lender needs to balance out their portfolio by diversifying their risk. They will only take a certain number of loans with a high debt-ratio; a certain number with low credit scores; and a certain number of self-employed borrowers, just as an example. If one lender turns you down it is not because your loan profile makes you unqualified; it could just mean that you are unqualified for the type of loan they are trying to fit into their portfolio.

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