What You Need to Know About Non-Qualifying Mortgages
Non-QM mortgages can be a good option for non-traditional borrowers
Non-qualifying, or non-qualified, loans—also called non-QM loans—offer a more flexible form of mortgage financing. They come with looser credit and financial requirements, and they’re usually good options for self-employed borrowers, some rental property investors, and others who don’t meet the strict standards of traditional mortgage loans.
What Is a Non-Qualifying Mortgage?
A non-QM mortgage is one that doesn’t adhere to the lending standards set out by the Dodd-Frank Act. These regulations were issued in 2014 to ensure borrowers have the ability to repay their loans and to prevent a repeat of the subprime mortgage crisis seen during the Great Recession.
Non-QM loans also aren’t eligible for purchase by Freddie Mac or Fannie Mae, nor do they come with government backing (like FHA and VA loans do, for example). As a result, they present a greater risk and typically come with higher interest rates.
“QM loans have a regulated formula to which mortgage providers must adhere, so if a borrower doesn’t check every box, they won’t qualify for a conventional mortgage or a government-insured or -guaranteed mortgage,” Joseph Watts, senior vice president of residential lending at North American Savings Bank (NASB), told The Balance in an email. “Non-QM lenders, however, will consider factors beyond that checklist and view the borrower's application from a more holistic perspective."
Why Seek a Non-Qualifying Mortgage?
Non-qualified mortgages are best for borrowers who can’t meet the requirements of traditional mortgage loans—such as a 43% debt-to-income (DTI) ratio or a certain credit-score minimum. Freelancers and other types of self-employed borrowers often use these loans, too, as they allow income to be verified in more creative ways, rather than only through W-2s and tax returns.
Here’s who might benefit from using a non-QM loan:
- Self-employed professionals, freelancers, and gig workers
- Low-credit borrowers
- Borrowers with high DTI ratios
- Borrowers with non-traditional income, including people living on investment proceeds
According to David Cook, strategic lending consultant at Contessa Capital, non-QM loans are particularly popular with real estate investors. “The lender can loan out funds based on the value of the asset,” Cook told The Balance in an email. “Asset-based lending is very common among real estate investors who are willing to pay a higher interest rate to purchase a rental property.” Non-QM lenders can also offer interest-only loans (these aren’t allowed on qualified mortgages), which are also a popular choice for investors.
Pros and Cons
The major advantage of non-QM loans is that they open the door to borrowers who may not otherwise qualify for a mortgage. As Watts of NASB put it, “They provide much-needed mortgage funding for the millions of hard-working but underserved Americans—like small-business owners and self-employed individuals—who’ve worked hard to achieve success but can’t qualify for a conventional conforming or government-insured or -guaranteed mortgage.”
These also may require less formal documentation than other loans. Non-QM lenders typically won’t require things like W-2s, tax returns, or an employment verification letter on these mortgages (though technically, they will require additional forms of income verification to “complete the financial picture of the borrower,” Watts explained.) They also come with more flexible terms, including balloon payment options and 40-year loans, which aren’t available on most qualified mortgages.
On the downside, non-QM loans come with higher interest rates and, often, lots of costly upfront fees. They’re also not as readily available, especially given the 2020 COVID-19 pandemic.
Lower credit scores allowed
Higher DTIs allowed
Allow non-salaried and other unconventional workers to buy or refinance a home
Flexible terms, including interest-only options
More forms of documentation accepted
Higher interest rates
Not readily available
Often come with high costs and fees
Who Offers Non-Qualifying Mortgages?
Not all lenders offer non-qualifying mortgages. You’ll need to check with local banks and credit unions, as well as various online mortgage lenders, to find a non-QM program you might be eligible for. Currently, NASB, New American Funding, and GuardHill Financial offer these loans, among others.
But be forewarned: Lenders change their loan products often and, according to Watts, many have opted out of non-QM loans since the COVID-19 pandemic spread to the U.S. in early 2020. Your best bet may be to contact a mortgage broker, who has access to dozens of lenders and can shop for non-QM solutions on your behalf.
Do Non-QM Rates and Fees Differ?
Because non-QM mortgages aren’t held to any broader regulatory standards, lenders have a lot of leeway in how they process and charge for these loans.
Less regulation often means non-QM mortgages come with higher rates and more costly fees and points than other loan options.
“Unlike in a Qualified Mortgage where the lender can’t collect more than a certain amount for points and fees, a non-QM lender has no restrictions on how much he charges to originate the loan,” Cook said. “Non-QM loans are more costly to obtain and keep through the lifetime of the loan.”
Explore Other Options
If you’re considering a non-QM due to your low credit or high DTI ratio, you have other options. FHA loans, for example, allow for credit scores as low as 500, while VA loans have no credit-score requirement at all (though individual lenders may have their own minimums).
If you’re buying a home in a rural part of the country and fall under your county’s income threshold, you may also qualify for a USDA loan. Though the credit-score minimum is 640 on these loans, the agency will also consider your history of payments for rent, insurance, utilities, department-store credit, and even child care to evaluate your credit, if necessary.
The Bottom Line
Non-qualifying mortgages can be a good option for self-employed borrowers, property investors, or others with non-traditional incomes or less-than-perfect credit scores. Still, they’re not without drawbacks. They often come with high upfront costs, as well as steeper interest rates—and that means more in long-term expense over time.
If you’re considering a non-QM, make sure to get quotes from several lenders, and use the loan estimates to compare your options. This can help you get the best deal possible on your mortgage.
Consumer Financial Protection Bureau. "Basic Guide for Lenders - What is a Qualified Mortgage?" Accessed Aug. 6, 2020.
Consumer Financial Protection Bureau. "What is a Qualified Mortgage?" Accessed Aug. 6, 2020.
U.S. Department of Agriculture. "Section 502 Direct Loan Program's Credit Requirements." Page 16. Accessed Aug. 6, 2020.