After the housing crisis and the start of the Dodd-Frank Act, you likely heard a lot about qualified and non-qualified mortgages. Non-qualified sounds bad, just like subprime does. But it’s not as bad as it sounds. Understanding the difference can help you determine which is right for you.
What are Qualified Mortgages?
Qualified mortgages are those that the lender went above and beyond to make sure you could afford the loan. You demonstrate the ability to repay the loan in several ways:
- Your debt ratio does not exceed 43%.
- You can fully document and prove your income using standard methods. This includes providing paystubs, W-2s, and tax returns if necessary.
- Your liabilities are fully verified and documented with accurate monthly payments
In addition to your ability to repay, the loan must meet several other qualifications. The lender controls these issues, though.
- The lender can’t charge more than 3% of the loan amount in total fees. This includes any points charged on the loan.
- There must not be a pre-payment penalty. You should be able to pay the loan off whenever you want.
- The loan may not be interest-only. It must be a fully amortized loan.
- There can’t be a balloon payment at the end of the term.
- The loan must not have a term that is excessively long.
If lenders follow each of these rules, they are protected against litigation from the borrower. The lender can’t claim that the lender falsely approved them for the loan. The lender can prove that they adequately qualified the borrower’s income, debts, and assets. They can also prove that they made sure the borrower could afford the maximum payment on the loan, in the case of an ARM.
Another benefit of the Qualified Mortgage loan is the lender’s ability to sell it on the secondary market. Lenders don’t have to keep the loans’ on their own books. They have the option to sell them and make room for new loans.
The idea behind the Qualified Mortgage program is to minimize the number of “bad” loans written. When lenders carefully evaluate a borrower’s ability to repay, they lower the risk of default. This helps not only the lender, but the borrower and the community as well. The fewer foreclosures that are out there, the less negative impact there is on property values. In the end, everyone wins from the little bit of extra work QM loans require.
What are Non-Qualified Mortgages?
Any loan that doesn’t fall into the QM guidelines is a non-qualified mortgage. Again, this isn’t necessarily a bad thing. It doesn’t mean you have bad credit or you fabricate your income. It just has something that doesn’t meet the QM guidelines. They are what you might call “creative” loans. They don’t meet the standard guidelines, but the lender still must make sure you can afford the loan.
One rule that is a commonality between QM and non-QM loans is the Ability to Repay Rule. Every borrower must meet this rule. It means that the lender made a good faith effort to ensure that you can afford the loan, whether or not it’s a qualified loan.
In general, the following differences occur in the non-QM loan:
- The loan usually has a higher interest rate and higher fees. This often makes it non-QM because it doesn’t fit within the 3% rule of QM loans.
- The borrower might not be able to verify his income the traditional way. Self-employed and wealthy unemployed borrowers are a good example. They may use their bank statements to qualify for a loan rather than paystubs and tax returns.
- The loan might have an interest-only feature or a balloon payment.
Again, the lender must make sure the borrower can afford the loan, no matter its type. The largest difference, however, is lenders must keep these loans on their books. Fannie Mae and Freddie Mac will not buy them. This means the lender creates their own portfolio with the loans on their books. It could limit the number of loans they write.
Who Are the Best Candidates for Non-QM Loans?
It might seem strange to think that anyone would willingly take a non-QM loan. With no restriction on fees or interest rates, it could be trouble. But, there are certain lenders that just don’t fit the mold. Their options are to not have a mortgage or take one from a non-QM lender. That being said, not all non-qualified mortgage lenders are bad.
The key is to shop around. You’ll find the lender that suits your needs the best this way.
Following are the most common borrowers to opt for non-qualified mortgages:
The most common borrower, as we discussed briefly above, is the self-employed borrower. Fannie Mae and the FHA often require borrowers to have a 2-year history of self-employment before qualifying for a QM loan. What if you just started your business but need a mortgage? You can opt for a non-QM loan. Many lenders have programs for self-employed borrowers. These programs allow the use of bank statements rather than 2 years of tax returns.
Another common borrower is the wealthy borrowers without a job. These borrowers don’t need to work. They live on the income from their investments. Again, this isn’t a steady job that a lender can prove. This precludes them from a qualified mortgage. A non-QM lender, however, can use the bank statements as proof of income and the ability to repay the loan.
Any borrower that suffered a negative economic event usually does best with a non-QM loan. For example, if you file for bankruptcy, you’ll have a required waiting period with FHA and Fannie Mae loans. A lender writing non-QM loans, though, may reduce that period. They may want to make sure you have fully recovered from the BK, but they may not make you wait 2 years or more like other programs.
Should You Take a Non-Qualified Mortgage?
The bigger question is whether you should take a non-qualified mortgage? Should you pay more for a loan? Keep in mind that not all non-QM loans cost more. It depends on the lender and the scope of your application. If you have a tricky situation, you’re going to pay for it, literally.
Lenders need to make up for the risk of default that your loan poses. If you had a recent BK, but the lender will give you a loan, you may pay a few points. Let’s say it’s a $200,000 loan and they charge 2 points. Is $4,000 worth it for you to get a loan now rather than waiting 2 years? That’s a personal decision, of course. But, it’s what you must consider when you decide if a non-QM loan is right for you.
It may even be possible to find a non-qualified mortgage for the same fee or rate as a QM loan. It depends on the lender and what you present to them. Don’t discount the benefit of the non-QM loan, though. If you need one and it’s the only way to get approved, shop around to find the deal that works best for you.