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Non-QM loans: How a non-qualified mortgage can help you buy a home

Yahoo Personal Finance· Getty Images
7 min read

If you are struggling to meet the requirements for getting a mortgage, you might assume homeownership is out of reach. Specifically, if you are self-employed or a gig worker — meaning it’s difficult to verify your income — or have an adverse credit history, you may find it challenging to qualify for a typical mortgage.

That’s where a non-qualified mortgage (non-QM) loan comes in. This type of mortgage loan does not have to follow the typical eligibility requirements, making it an avenue to homeownership for people with atypical financial situations. But non-QM loans do have some serious drawbacks that borrowers should consider before pursuing one. Here’s what you need to know about non-QM loans.

Read more: What credit score do I need to buy a house?

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To understand non-qualified mortgage loans, it’s helpful to start with a definition of qualified mortgage loans.

Qualified mortgages are what you might think of as “regular mortgages.” They must adhere to four consumer protection criteria outlined by the Consumer Financial Protection Bureau (CFPB). These requirements were developed to ensure homebuyers could afford the mortgage lenders offered them and avoid foreclosure.

A lender must follow the “ability-to-repay” rule when offering a qualified mortgage. This guideline follows four general criteria:

  1. Verification of debt and income. A lender must verify your income and assets, make sure you can afford monthly payments on top of other existing debt payments, and check that you’ll have money left over after closing the loan.

  2. Restrictions on risky loan features: Specifically, the CFPB prohibits qualified mortgages from offering interest-only payments, balloon payments, or loans likely to result in negative amortization even when you make regular on-time payments.

  3. Loan pricing limits: The guidelines set an annual percentage rate (APR) threshold that your lender cannot cross for a qualified mortgage. The specific APR limit will generally depend on the type of loan you are taking and the size of your loan.

  4. Up-front point and fee limits: The CFPB limits the up-front discount points and fees your lender can impose on your qualified mortgage loan. Any home loan with mortgage discount points and fees greater than the CFPB’s threshold will be considered a non-QM loan.

Learn more: What is a balloon mortgage payment?

Non-QM loans do not have to follow the CFPB guidelines for qualified mortgages. This means they are easier to get if you do not fit the usual profile of a homebuyer.

Any non-QM mortgage may bypass one or more of the CFPB guidelines for qualified mortgages, but you might find some common characteristics or terms among non-QM loans. Here are some of the features of non-QM loans you might encounter:

  • Fewer documents required to verify income: Self-employed borrowers, freelancers, and gig workers may struggle to meet the income verification requirements for a qualified loan. Qualified mortgages typically require tax returns and pay stubs to verify your income, but non-QM loans may only ask for bank statements.

  • 40-year repayment term: The longer your loan term, the lower your monthly payments will be. Borrowers who would struggle to afford monthly payments under a standard 30-year term could potentially afford payments with a 40-year term — but the loan cost is much higher overall because 40-year mortgages charge higher rates and have an extra decade to accumulate interest.

  • Higher debt-to-income ratio allowed: Debt-to-income ratio (DTI) refers to the amount you pay toward debts every month compared to your gross monthly income. The higher your DTI, the more likely you are to struggle with making your monthly mortgage payments.

  • Allowance of adverse credit: Even if your credit history is not good enough to qualify for a qualified mortgage, you may be able to take out a non-QM loan.

While each of these non-QM loan features can make it easier to qualify for a mortgage, they will also typically increase the cost of your mortgage, either due to higher interest rates or longer terms.

Learn more: How to get a mortgage with good (but not great) credit

Although the CFPB created the qualified mortgage guidelines to help protect borrowers, there are some valid reasons for seeking a non-QM loan. The following types of borrowers may not be eligible for a qualified mortgage loan, so a non-QM mortgage can be a good path to homeownership:

  • Non-traditional workers: If your income is difficult to verify, either because you own your own business, are a gig worker, or have plenty of assets but relatively low income, a non-QM loan can help you bypass the onerous income verification requirements.

  • Real estate investors: People who invest in real estate may have a debt-to-income ratio that’s too high to qualify for a QM loan, even if they’re otherwise in a good position to afford monthly mortgage payments.

  • Borrowers who need a lower monthly mortgage payment: Homebuyers who could afford a mortgage payment on a 40-year repayment plan or with an interest-only loan may qualify for a non-QM loan even if a qualified mortgage is out of reach. This may be especially helpful to lower-income borrowers in areas with higher cost of living.

  • Borrowers recovering from a recent bankruptcy: It’s nearly impossible to qualify for a qualified home loan after a recent bankruptcy. Borrowers on track financially despite their recent bankruptcy may qualify for a non-QM loan.

Looking for non-QM lenders? Read the following Yahoo Finance reviews:

Just because a non-QM loan can work for some borrowers doesn’t mean it’s the right choice for everyone. There are several reasons why a non-QM loan could hurt your financial situation rather than help you become a homeowner. Borrowers need to consider the following questions before taking out a non-QM loan:

  • Can you afford the mortgage payments in the long term? If your cash flow is truly irregular and you don’t have resources to smooth over low-income periods, you may struggle to continue making monthly payments on time.

  • How much will the non-QM loan cost over the life of the mortgage? Make sure you calculate the total amount you will pay in interest and fees for the life of the loan, then decide whether you’re comfortable with these numbers.

  • What would it take for you to qualify for a qualified mortgage? Improving your personal finances so you are eligible for a qualified loan may ultimately be cheaper than taking a non-QM loan now.

Dig deeper: Use Yahoo Finance’s free mortgage calculator

A qualified mortgage loan must adhere to the CFPB’s guidelines for mortgage lending. That means the lender must verify your ability to repay the loan by documenting income and assets, avoid risky loan features, keep APRs below the listed limits, and limit the amount of up-front points and fees. Non-qualified loans are not required to meet these guidelines, making it easier for you to qualify.

Borrowers with low credit scores or adverse credit histories may be able to qualify for a non-QM loan. However, non-QM loans generally charge higher interest rates and offer less favorable terms than qualified loans. Borrowers with bad credit may find it less expensive to take a few years to improve their credit and then attempt to qualify for a qualified loan.

A mortgage with a 40-year repayment term is a type of non-qualified mortgage. Qualified loans have term lengths of 30 or fewer years.

This article was edited by Laura Grace Tarpley