Non-Qualified Loan

What Types of Non-QM Loans are There?

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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.

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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.

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Understanding the Characteristics of a Non-Qualified Mortgage

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FamilyIf 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.

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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.

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Role of Non-Qualified Mortgages in Residential Home Lending

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Role of Non-Qualified Mortgages in Residential Home Lending

In the wake of the mortgage crisis, subprime mortgages seemed to go by the wayside. They were suddenly just not available since the finger was being pointed at them for the reason for the downfall. Was that the reason? No one will truly know, but the good news is that subprime mortgages have made a comeback, just with a new name. That new name is the “non-qualified loan.” The name came about as a result of the new guidelines set forth by the government. After the housing crisis, all loans had to be a “Qualified Loan.” If it did not fall within these guidelines, it was not qualified and the borrower could not come back at the lender if they were to default.

Qualified Mortgage Guidelines

A qualified mortgage is one that the lender can prove without a doubt that you can afford. This is not a subjective decision either; the government set forth specific guidelines that each loan must meet in order to be considered qualified. These guidelines include:

  • A debt ratio cannot be higher than 43 percent – no exceptions
  • The money the lender charges for discount points or origination fees cannot total more than 3 percent of the loan
  • The loan must be a straightforward amortization
  • You must provide adequate proof of your income
  • The term cannot be longer than 30 years

What does it Mean to be a Qualified Loan?

Aside from meeting the above guidelines, qualified loan holders have a little more justification should they default on their loan. With a qualified mortgage, the borrower has the right to sue the lender if he were to be unable to afford the loan down the road. In addition, lenders are subjected to penalties if they provide loans to borrowers under the QM guidelines and they do not meet them. The qualified loan basically means that the lender evaluated every possible aspect of the loan file to determine that it is a good fit for the borrower.

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The Non-Qualified Mortgage Loans

The good news is that the borrowers that do not fall under the qualified guidelines can still obtain a mortgage. They actually have a little more leeway, which is where non-qualified loans come across as subprime loans. Not every lender is going to offer this type of loan because they are unable to sell it on the market – they have to keep the loan in their own portfolio. This might require you to do a little shopping around to find the right lender.

Borrowers that do not meet the QM guidelines will need to have compensating factors to make up for the downside of their loan file. For example, a higher than 43 percent debt ratio would need a compensating factor in order for the lender to see that it is not a completely risky loan. One way to offset a high debt ratio is with adequate reserves in your bank account. If you can show the lender that you have 6 to 12 months’ worth of reserves on hand, your loan suddenly becomes less risky.

Something that is very different for non-qualified loans versus subprime loans is the work the lender needs to do to make sure you meet the “ Ability to Repay” rules. These rules require lenders to ensure that they verify your income, assets, and employment as well as ensure that your debt ratio is accurate and that they take a close look at your credit history. What this means basically, is that you cannot have any type of “stated income” loan, although there are ways around that as well. If you cannot prove your income the standard way, you can get away with using bank statements to prove your income. This is a version of a stated income loan but with an alternate verification.

In the end, everyone gets funding, it is just a matter of how you get it. Yes, QM loans have lower interest rates and lower fees, but conventional loans always had lower rates and fees than subprime loans did too. The key factor is that you are able to get a loan that you can afford, getting you into the home you desire.

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