If a mortgage doesn’t comply with the Qualified Mortgage Rules, it’s a non-qualified mortgage. Don’t think of it as a ‘bad loan,’ because it’s not. Instead, it’s an alternative loan that lenders don’t sell on the secondary market. It’s good for borrowers that don’t meet the strict QM guidelines and need a little leeway for approval despite being able to comfortably afford the loan.
What Makes a Loan Non-Qualified?
A loan is not a Qualified Mortgage if it doesn’t meet the following guidelines:
- A max debt ratio of 43%
- Verifiable income through standard channels, such as paystubs, W-2s, and tax returns
- No more than 3% in points and fees charged by the lender
- No risky loan features, such as interest-only, balloon terms, or negative amortization
Loans that don’t meet these requirements don’t fall under the QM guidelines and cannot be sold to Freddie Mac or Fannie Mae.
Loans Outside of the Box
A good way to look at non-qualified loans is loans that are outside of the box. Not all non-QM loans are the same. They vary by lender because the lender keeps the loan on their books. In other words, they don’t sell it to Freddie Mac or Fannie Mae.
A few examples of what different lenders may allow include:
- Higher than 43% debt ratio with compensating factors, such as a high credit score
- Approval of a mortgage before the standard waiting period after a foreclosure or bankruptcy ends
- Irregular income that you cannot prove with paystubs or tax returns
These are just a few examples. Because each lender can have their own requirements, you can find many more programs that lenders offer that might fit your situation.
Compensating Factors are Necessary
Even though a non-qualified loan is a bit more lenient, it doesn’t mean lenders just hand out the loans to anyone. The days of stated income or no-income loan are gone. You have to verify your income in some way, even if it’s an alternate way, such as with bank statements.
In order to make up for the risk, though, you’ll need compensating factors. These are things that make up for the fact that your loan doesn’t meet the QM guidelines. A few examples include:
- A low debt ratio – The lower your debt ratio is, the lower your risk of default. If you show a lender that you don’t have a lot of outstanding debt taking up your income, it means you have more income available to cover the mortgage payment.
- A high credit score – Your credit score is the lender’s first impression of your financial responsibility. If you have a high score, it shows lenders that you are able to handle your finances by paying your bills on time and not overextending yourself.
- Assets on hand – The more money you have available after paying the closing costs and down payment on a home, the better your chances of approval. Lenders call this money reserves. They calculate it based on the number of months the assets cover the mortgage payment. For example, if you have $3,000 on hand and your mortgage payment is $1,000, you have 3 months of reserves. The more reserves you have, the better your chances of approval.
A non-qualified mortgage is basically a mortgage that a non-conforming lender provides. The loan can’t be sold on the secondary market. Instead, the lender that funds the loan also keeps it on their books; they will likely be your loan servicer.
As a borrower, there isn’t much difference in a non-QM loan with the exception of how the lender verifies your qualifying factors. You might pay a slightly higher interest rate, but that’s not required. You should shop around and find the lender that offers the best deal. If you find a lender gauging you on the interest rate or fees, look for another lender. Non-QM loans aren’t any riskier than QM loans – it’s just an alternative way to verify that you can afford the mortgage.