An Introduction to Non-QM Programs
Why it is a Great Alternative for Borrowers
By Jennifer McGuinness
In the current and ever-changing market environment, it is important to understand the different financing options available to borrowers. Non-QM Programs offer a wide range of flexibility and underwriting criteria. These loans are available for the financing of primary residences, second homes and investment properties, but many do not know what non-QM means or how to get started.
What is a Non-Qualified Mortgage (“Non-QM”)
A non-QM mortgage loan is a home loan that is not required to meet the requirements outlined by the Consumer Financial Protection Bureau (CFPB). In January 2014, the CFPB issued a set of guidelines to provide “safer and more stable” home loans for consumers called Qualified Mortgages.
Qualified Mortgages are a “new” mortgage classification. Commencing in 2014, the concept was created to make it more likely that a borrower would be able to pay back the loan. Lenders need to assess the borrower’s ability to repay and borrowers need to meet a strict set of criteria. If borrowers do not meet those criteria, they will not be approved for a qualified mortgage. In these situations, a borrower may be offered a non-qualified mortgage.
A non-QM loan does not conform to the consumer protection provisions of the Dodd-Frank Act but that does not mean that they are bad for the consumer. Applicants whose incomes vary from month to month or those with other unique circumstances may qualify for these types of mortgages.
For example, if you have a debt-to-income ratio of more than 43%, a lender may not offer you a qualified mortgage. Or, if you have dynamically changing income and do not meet the income verification requirements set out in Dodd-Frank and required of most lenders, you may not be offered a qualified mortgage.
A lender may instead offer the borrower a non-qualified mortgage. If a lender offers a non-qualified mortgage, it does not mean the lender is not required to do any verification or assessment of your ability to repay the loan. It generally means that you do not meet the specific criteria needed for a qualified mortgage.
Interest rates on loans will vary from lender to lender, but you may find that a non-qualified mortgage will have a higher interest rate.
The Loan Differences
While there are differences in how a Borrower qualifies for a qualified mortgage vs. a non-qualified mortgage, there are also differences in the loans themselves. Here are some of the ways the loans differ.
Dodd-Frank offered lenders issuing QM mortgages protection from certain legal challenges in foreclosure proceedings and other litigation. With a QM mortgage, lenders generally have shown that they have confirmed that the borrower had the ability to repay the loan, which provides the lender with certain legal protection from lawsuits that claim they did not verify a borrower’s ability to repay. However, if a borrower does not feel that the lender made sure they had the ability to repay, they can still challenge the lender in court.
Additionally, only QM mortgages can be insured, guaranteed or backed by FHA, VA, Fannie Mae or Freddie Mac, so they are generally considered “safer” for investors who buy mortgage-backed investments. BUT IS THIS TRUE?
The non-QM share of total mortgage counts declined during the COVID pandemic and reached its lowest level in 2020, at 2% of the market. However, the non-QM share of the market has since almost doubled in 2022, representing about 4% of the first mortgage market (data is as of the first three months of 2022). Though the non-QM loan is a small piece of today’s mortgage market, it plays a key role in meeting the credit needs for borrowers not able to obtain financing through Fannie Mae, Freddie Mac or other government channels.
Creditworthy borrowers such as self-employed borrowers, first-time homebuyers, borrowers with substantial assets but limited income, jumbo loan borrowers and investors may benefit from non-QM loan options.
The three main reasons why non-QM loans originated in 2022 did not fit in the QM requirements are the use of limited or alternative documentation, a DTI above 43% and interest-only loans. Almost 55% of the non-QM borrowers used limited or alternative documentation, 26% exceeded the 43% DTI threshold and 23% of the non-QM mortgage loans originated were interest-only loans.
Today’s non-QM loans are still high-quality loans. They are very different and less risky than the equivalent of non-QM loans originated prior to the housing crisis.
The average credit score of homebuyers with a non-QM mortgage loan in 2022 was 771 compared to 776 for homebuyers with QM loans and 714 for government loans (data is as of the first three months of 2022). Similarly, the average Loan to Value Ratio (“LTV”) for borrowers with non-QM mortgages was 76%, compared to 77% for borrowers with QM mortgage loans. Finally, the average DTI for homebuyers with non-QM loans was 37% versus 33% for QM and 40% for government programs.
Despite the higher DTI ratios, non-QM mortgages are performing very well. Both the non-QM and QM loans have low delinquency rates. In fact, the serious delinquency rate (over 90 days delinquent) for non-QM mortgages is slightly higher than the rate for QM loans (both being less than 1%) and significantly lower than for the government loans (almost 2%).
To offset the risk of default, lenders generally set a higher interest rate on non-QM loans. Additionally, lenders are generally focused on borrowers with higher credit scores and lower LTVs, as this helps to offset the possible added risk from a high DTI ratio, limited documentation and interest-only on non-QM loans.
How Do Lenders Verify Income for Non-QM Loans?
While non-QM loans offer flexibility for lenders to offer mortgages to people who do not fit the criteria of QM loans, lenders still need to verify the information provided and document anything that supports the borrower’s ability to repay. That includes income sources, assets, or anything else that gives them assurances the borrower will be able to repay the loan. Some examples include a review of 12 or 24 months of bank statements and asset statements, self-employed or 1099 documentation, written verifications of employment, one-year tax return underwrites versus the agency required two years, etc.
As you can see, non-QM loans add allowances to provide financing to a vast array of borrowers which allows enhanced access to credit. This does not mean that the loans are “bad” or “more risky,” it solely means that the borrower’s documentation and information may be more complex than the documentation or information needed to qualify for a QM Mortgage.
