Non-QM Loans: Guide for First-Time Home Buyers

Introduction to non-QM loans

No longer a dirty word in the lending space, non-QM loans are “non-qualified mortgages.”

They have more flexible borrower requirements than the more usual qualified mortgages. So, if you’re self-employed or work in the gig economy, have irregular cash flows, or have a poor credit history you might not be able to get a qualified mortgage. But you may well see your application for a non-qualified mortgage approved.

Learn about the loan type and the qualifications needed to potentially be approved for one.

What are non-QM home loans?

Nearly all home loans are qualified mortgages. That means lenders had to ensure their borrowers met strict standards laid down by the federal regulator, Consumer Financial Protection Bureau (CFPB).

The “ability-to-repay” (ATR) rule is central to those standards. It means lenders have to check and document that each borrower can comfortably afford the monthly payments on their loans.

Lenders must do that using measures such as credit scores, debt-to-income ratios, and loan-to-value ratios. They also must ensure that borrowers have consistent and sufficient incomes.

Borrowers who need non-QM loans

The vast majority of homeowners clear these hurdles with greater or lesser ease. But members of a much smaller group stand little chance of ever getting a qualified loan.

Many of them simply have irregular cash flows. They might be self-employed; business owners, freelancers or workers in the gig economy.

Others may have poor credit scores or a heavy debt burden. Some might have had a recent bankruptcy or foreclosure.

How non-QM loans work

People in those groups may be able to get non-QM loans. However, not all will. Lenders won’t lend to people they think stand little chance of paying them back.

As importantly, those lenders will generally be taking on a greater risk than with most borrowers of qualified mortgages. And they’ll require a higher reward to balance that risk.

So, mortgage rates, fees, and down payment requirements tend to be appreciably higher for these mortgages. And, because non-QM loans are almost entirely unregulated, lenders have no caps on what they can charge.

But that lack of rules means lenders can structure their loans with greater flexibility. And things like balloon payments, interest-only mortgages, and even negative amortization aren’t uncommon.

Occasionally, that flexibility attracts rich borrowers who find this type of structuring helpful for tax, investment or cash-flow management purposes. And they may get competitive fees and rates because of the relatively low risk they pose.

Think of non-QM loans as unrestrained capitalism, largely free of regulation. It’s up to you and a lender to negotiate a deal that works for both of you. If you can’t, one of you will walk away.

Did non-QM loans cause the 2007-2008 housing crash?

The naming conventions of “qualified” and “non-qualified” mortgages didn’t exist during the 2000’s housing crash.

However, the closest parallel were subprime mortgages and many economists believe they triggered that crash — and the wider financial crisis that became known as the Great Recession. We define subprime mortgages as ones with borrowers with poor credit scores.

And, although some non-QM loans are subprime, many are not. Plenty of non-QM borrowers have good or great credit scores. And they choose this type of borrowing only because they have irregular incomes or high levels of existing debt. Or perhaps because they’re high-net-worth individuals seeking tax or other advantages.

Congress created qualified mortgages when it enacted the Dodd-Frank Act of 2010. That was an attempt to stop a recurrence of the housing crash, credit crunch and another massive recession. The rules surrounding them were first published on Jan. 30, 2013 and implemented in 2014.

Are non-qm loans safe now?

Non-QM loans are now very unlikely likely to cause a systemic banking crisis like subprime mortgages in 2007. Even if some unexpected disaster befell them, there aren’t enough to cause a widespread crash.

While no mortgage (including a conventional, qualified loan) is 100% safe, non-QMs are now safer for borrowers as well. Although, it’s highly likely non-QM loans post higher default rates than mainstream mortgages due to the inherently more risky terms and share of borrowers with lower financial profiles.

However, non-QM lenders haven’t given up on weeding out the worst risks. Instead, they’ve developed different ways of assessing borrowers’ creditworthiness.

They’ll view an applicant’s finances holistically. True, they’ll use different criteria from mainstream lenders when making a lending decision. But they’ll want to avoid making losses from bad debts just as much.

Indeed, they’re incentivized to be even more careful. Freddie Mac and Fannie Mae loans and government-backed ones (FHA, VA and USDA loans) allow lenders to share some of the risk of bad-loan losses. But, with non-QM loans, the lender shoulders the entire risk burden.

Reasons to get a non-QM loan

Non-QM lending typically benefits those who can’t get approved for qualified mortgages. They may have poor credit, excessive existing debts, or recent bankruptcies or foreclosures.

But many are simply self-employed or business owners. Or they may be working as freelancers or in the gig economy.

For them, the problem isn’t necessarily their financial position, which may be strong. It’s that they can’t come up with the paperwork that shows their income streams meeting the exacting standards that qualified mortgages require.

Yet other non-QM borrowers may be wealthy and prefer the deal they can get on a non-QM loan because it delivers tax or investment advantages.

As we said earlier, these aren’t synonymous with subprime mortgages.

Who offers non-QM loans?

Don’t expect every mortgage lender to offer non-qualified mortgages. Many — perhaps most — regard them as too exotic to include in their portfolios.

But that doesn’t mean they’re particularly difficult to find. A good starting point is the Scotsman Guide, widely considered a credible source by the mortgage industry. Its 2022 Top Non-QM Lenders list shows America’s 25 biggest non-QM lenders by volume.

Note that some but not all of these lenders are licensed in all 50 states. Before requesting a quote, be sure to check if they operate in your state. You’ll find the information you need on each lender’s website.

The Scotsman’s top-5 picks are:

1. Fairway Independent Mortgage Corp.
2. Angel Oak Lending
3. Guaranteed Rate
4. CoreVest Finance
5. Acra Lending

Some of those are famous names in the mortgage industry. Others well-known lenders on the list include:

• Guaranteed Rate Affinity
• CrossCountry Mortgage LLC
• loanDepot
• Finance of America Mortgage
• Homebridge Financial Services

Whether you prefer to go with a big-name lender is up to you. Still, as with all mortgage shopping, you need to get competitive quotes from multiple lenders to make sure you get the best deal possible.

The bottom line

The mortgage market effectively locks out a significant number of would-be homeowners. They can’t get past the straightjacket rules that govern applications for qualified mortgages.

That’s where non-qualified mortgages come in. Non-QM lenders can be more flexible when approving an application. That means you can get a home loan even with a low credit score, a high DTI ratio or even a recent bankruptcy.

If this sounds like a good path to homeownership, reach out to a local lender today and see what your options are.