All You Need to Know About Non-QM Loans

A non-QM (non-qualified mortgage) loan is a mortgage that doesn’t meet the strict criteria set by the Consumer Financial Protection Bureau regarding loan size, repayment model, or borrower requirements. Non-QM loans are typically used by people with special requirements, such as investors, self-employed people with large cash reserves, or foreign nationals. 

In this article, we will cover what they are, the different types of non-QM loans, their pros and cons, and how to find the right one, depending on why you need it. 

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What Is a Qualified Mortgage (QM) Loan?

A qualified mortgage loan is one that meets certain federal guidelines that are meant to prevent lenders from lending to unqualified borrowers. These guidelines were created after the subprime mortgage crisis of 2008, when banks provided subprime mortgages to individuals who then defaulted on their payments, causing a recession. 

The Four Rules of QM Loans

The Consumer Financial Protection Bureau (CFPB) imposes four primary rules for QM loans, which include:

• First lien – QM loans are asset-based loans, meaning they are secured by the house that is being mortgaged.
  
• Fixed rate – Only fixed-rate loans qualify.
  
• Regular payment requirements –The requested payments must be regular, mostly equal, and fully amortized. That is, they must also cover interest payments. This means you can’t have negative amortization, as happens with interest-only loan options.
  
• No balloon payments – Balloon loans, such as hard money loans, are non-QM loans.
  

For a qualified loan, the borrower's debt-to-income ratio can be 43% or lower, and the lender can charge 3% of the loan amount in origination fees. The CFPB also requires lenders to verify the borrower’s income to ensure they are capable of paying the loan balance. 

The Rise of Non-QM

The technical requirements of a qualified mortgage exclude many creditworthy Americans with a strong ability to repay their loans.

For instance, what happens when the self-employed contractor with multi-millions doesn’t qualify for a qualified mortgage because he doesn’t have the documentation needed? The guy with the ten-million-dollar net worth and perfect credit should be an ideal borrower, right?

In the last several years, lenders and the capital markets have started to serve these people and fill the gaps. Capital markets have gotten increasingly comfortable with non-QM mortgages, and lenders have gotten increasingly better at putting reasonable processes into place to determine the borrower’s ability to repay.

QM vs Non-QM Loans

Both qualified mortgages and non-qualified mortgages can be divided into two categories: consumer purpose loans and business purpose loans. Most loans backed by the federal government are consumer loans, but there are some investment property QM loans.

Similarly, most non-QM loans are for investors, but there are some exceptions for owner occupiers. Some of this key criteria includes limiting risky features such as allowing for interest only payments, negative amortization, extended loan terms. or balloon payments. There are also stringent requirements on income and credit history verification.

To get a clearer picture, let's take a look at the different kinds of QM loans and non-QM loans

Types of Traditional Mortgage (QM) Loans

As we previously stated, qualified mortgage loans are loans that meet the guidelines set forth by the Consumer Financial Protection Bureau's criteria, which ensure a borrower’s ability to repay their loan.. There are many buckets of QA loans including FHA Loans, VA Loans, and conventional loans for investment properties.

FHA Loans

These loans are designed for low-income borrowers and offer lower down payments and options for low credit scores.

VA Loans

These loans are designed to help veterans become homeowners and are backed by the U.S. Department of Veterans Affairs. VA loans are unique as they do not require a down payment. Similar to FHA loans, if one of the units is a primary residence for the borrower, they can rent the others out. 

QM Loans for Investment Properties

This type of mortgage loan is VA loans are unique as they do not require a down payment. Similarly to FHA loans, if one of the units is a primary residence for the borrower, they can rent the others out. 

Types of Non-QM Loans

Non-QM mortgage loans, on the other hand, are home loans that fit outside the rules of a qualified mortgage. There are also many types of non-QM loans, such as jumbo loans, bank statement loans, foreign national loans, and more. It can also include investor loans, such as Visio's Rental360 Loan Program. 

Jumbo Loans

A jumbo loan is a loan that exceeds the limit established for Fannie and Freddie, which is $548,250 for 2021. Jumbo loan borrowers can be either owner occupiers, second home purchasers, or investors looking for a larger sum of money than the agency limit.

Bank Statement Loans

These loans are also known as self-employed mortgages or alternative documentation loans. To qualify for one, a borrower can use their personal and/or bank accounts to prove their income rather than W2s and tax returns.  

In other words, bank statement loan lenders look carefully at a number of borrower bank statements. These loans are ideal for self-employed borrowers or contractors who do not meet agency requirements based on tax returns.

Foreign National Loans

Fannie and Freddie do not offer loans to foreign nationals, but there are still loan programs for these individuals. Foreign national loan programs are designed for non-residents looking to purchase real estate in the United States.

Interest Only Loans

 An interest-only loan is a type of non-QM loan in which you pay only the interest for a given amount of time and then repay the entire loan amount at once. This is helpful for investors such as house flippers as it allows them to purchase a property and repay the loan in full once they sell it.

Investor Loans

Investor loans are loans originated for property purchasers who are not owner occupiers and usually are underwritten based on the cash flow of the property rather than personal income.

Measuring the property's profitability rather than the borrower’s income enables investors to acquire multiple properties. It also simplifies the process by taking out the need to look at bank statements, pay stubs, or tax returns.

Non-QM Loans vs. Conventional Loans

A conventional loan is a home loan that is not backed by the government. Like a conventional loan, a non-qualified mortgage is also one not backed by the government. However, conventional loans typically meet the guidelines of Fannie and Freddie, which are government sponsored entities. 

QM vs Non-QM Investment Loans

When it comes to financing an investment property, qualified mortgages are the most affordable option with the lowest interest rates, yet they have strict guidelines in place. Investors just getting started, particularly those with high income, are drawn to QM loans. Newer investors are often able to document their income and meet the strict criteria set forth by Fannie Mae and Freddie Mac.

On the other hand, non-qualified mortgage investment loans meet the needs of professional investors with portfolios of rental properties. Non-QM loans are much easier to qualify for, despite the larger expense.

Not to mention, professional real estate investors are focused on building wealth over time and growing their monthly cash flow. In the big picture, the slightly higher investment property mortgage rates are outweighed by the significantly greater flexibility they have to achieve their larger investment goals.

Pros and Cons of Non-QM Loans

A non-QM loan can make perfect sense for some investors, especially self-employed individuals who may not be able to qualify for a traditional loan. However, they have some downsides that borrowers must be aware of before signing on the dotted line.

Non-QM Loan Pros

The pros of a non-QM loan include:

• Less stringent documentation requirements – Non-QM loans typically don’t require the exhaustive financial documentation of qualified mortgages, like pay stubs and tax returns. Credit requirements may also be more flexible.
  
• More flexible borrower profiles – Self-employed borrowers struggle to get a traditional mortgage loan because mortgage lenders feels they don’t have a stable income and may not be able to repay the loan. A non-QM lender will work with a larger variety of borrowers because they have alternative methods of identifying one’s ability to pay. 
  
• Larger loan limits – Non-QM loans are often non-conforming loans, meaning that they exceed the conforming loan limit. Non-QM loan borrowers can often get larger loan amounts.
  
• Tailored loan terms – Some non-QM lenders may provide a loan term shorter or longer than 30 years, or they may allow for interest-only payments.
  

Non-QM Loan Cons

The cons of non-QM loans include:

• Higher down payment requirements – The average down payment for a non-QM loan is typically 20%, but some will ask for as much as 35% if you have a low credit score.
  
• Higher interest rates and fees – As non-QM loans are riskier, lenders charge more interest. There may also be higher lender fees, such as closing costs.
  
• Potential for default – Certain non-QM loans are much riskier for the borrower, such as hard-money loans that have interest-only options. This can put you at risk of being unable to make your mortgage payment and thus defaulting on your loan. (Check out our alternatives to hard money loans to find safer choices.) 
  
• More difficult to find – A non-QM loan is a specialized mortgage product, so not every mortgage lender will offer it. 
   

Why Non-QM Loans Appeal to Investors

While it is possible to obtain agency financing for investment properties, the underwriting guidelines can be restrictive. 

Non-QM Investor Loans are Underwritten Based on Property Cash Flow

Experienced investors with multiple mortgaged investment properties and self-employed professionals without W2s often have difficulty meeting personal income requirements. Non-QM investor loans also have lower documentation requirements than traditional qualified mortgages. 

Non-QM Loans Allow Investors to Borrow in an LLC

Many experienced investors prefer to borrow through an LLC or corporation to protect their identity and other investments. Fannie Mae or Freddie Mac loans can only be obtained in an individual(s) name.

Non-QM Loans Enable Investors to Quickly Grow Their Portfolio of Rentals

Even if you have enough personal income to support multiple mortgages, with federal government sponsored loans, you are maxed out at ten loans. Non-QM lenders do not have a limit offering investors the opportunity to grow their portfolios before other investments are fully paid off.

What Should You Look for in a Non-QM Investor Loan?

There are many non-QM investment mortgage lenders on the market, and determining which one is the best for you can be overwhelming. We always recommend consulting a financial advisor. In the meantime, here are some questions to consider.

What are the lender’s interest rates and fees?

While this may sound like a given, it is important to know exactly what your costs will be for the loan. The last thing you want is to end up at the closing table with unexpected costs. Make sure you have a clear picture of any underwriting fees, legal fees, and any possible factors that could adjust your rate.

What are the lender’s eligible property types?

Different non-QM lenders allow for different properties. For example, some non-QM lenders do not allow non-warrantable condos, boarding houses, or multi-family homes. Lenders also have different requirements and programs for property condition.

Is the lender investor-friendly?

Lenders who work with investors regularly typically have the optionality to meet your investment strategy. For instance, Visio has prepayment penalty and rate buy-downs as well as a selection of rate structures including interest only loans, to provide investors the flexibility they need.

Secure a Non-QM Loan from Visio Lending

Visio is a leading provider of non-QM mortgage products. Our Rental360 is underwritten based on rental income and borrower credit history, rather than the borrower’s personal income.  As a result, the Rental360 is an ideal financing product for the self-employed investor or the investor that is building a portfolio of properties.