Non-QM (Non-Qualified Mortgage) loans are flexible mortgage options designed for borrowers who may not meet traditional lending criteria, such as self-employed individuals or those with more unique income streams.
As the cost of basically everything continues to increase and mortgage rates remain elevated, potential homebuyers are doing everything they can to increase their earning power. Side gigs, contract work, going into business for themselves and content creation are just some of the creative ways folks are piecing it together to get everything they can out of life.
Getting qualified for a home loan using traditional income verification methods is becoming more and more difficult as home prices increase, the supply of homes on the market can’t keep up with demand, and mortgage rates remain stubborn. For some borrowers, those traditional income verification methods don’t capture the full picture of their qualifications to buy.
With all these phenomena swirling around at the same time, non-QM mortgage options have become more and more popular. They have always been a great solution for certain types of borrowers, and these days, that number is growing.
“Non-QM loan products are spiking in popularity due not only to a persistent high-rate environment, but some potential buyers are finding more and more that traditional financing options just don’t work for them,” said Ashley Duenas, Vice President of Product Training and Development at Fairway. “As income sources become more diverse, documenting that income can become particularly challenging in standard or ‘normal’ home loan scenarios.”
So, what exactly are non-QM home loans, and who are they for? Let’s take a look past all the mortgage industry jargon and put it into plain terms.
Non-QM loans are mortgages that don’t meet the Consumer Financial Protection Bureau’s requirements to be considered “qualified.” They fall outside the parameters of Conventional loans or government-backed loans such as VA, USDA or FHA mortgages, because these more typical mortgages require income to be documented in certain ways — mainly tax returns and W-2s. Non-QM loans, however, are aimed at borrowers whose financial profiles don’t meet the requirements of a typical qualified mortgage — but that doesn’t mean these folks aren’t qualified to own a home or that they’re somehow more likely to become delinquent on their debts! In fact, oftentimes (but not always), non-QM home loan applicants are high-net-worth individuals or those who have large wealth in assets that can be translated to monthly income for the purposes of a home loan.
Their circumstances often include nontraditional income or inconsistent income structure throughout the year. Or sometimes, they may have higher than normal debt or have a major credit event in their past.
Existing outside of the rules of qualification gives non-QM lenders like Fairway a lot of freedom, both in who they can approve for a home loan and in the features of those loans. Non-QM options provide greater freedom and flexibility with regard to income verification, debt-to-income ratio and potentially payment terms, at a cost. Non-QM borrowers may have to make a larger-than-average down payment or pay a slightly higher interest rate over the life of the loan.
At Fairway, we offer several different types of non-QM loans in our continual effort to help as many people as possible achieve the dream of homeownership. Many of them can take a similar shape to the more common “qualified” mortgages you may be familiar with: They may have 15-, 30- or even40-year terms with fixed interest rates, and there may be adjustable-rate options as well. Let’s take a look at some of the most common types of non-QM loans and what type of borrower those loans are tailored toward.
Put simply, a bank statement loan is a mortgage in which the borrower demonstrates his or her ability to repay based not on standard methods like tax returns and W-2s, but on the amount of larger financial assets in their possession, whether they be balances in checking, savings or money market accounts. Oftentimes these assets are used in combination with the borrower’s income to qualify. It’s not always one versus the other.
These borrowers could be self-employed, sure, but that’s not always the case. They could be a W-2 worker who may not make enough to qualify advantageously for a Conventional or government-backed loan, but who also received a sizeable inheritance, just as one example. The point is flexibility.
Self-employed borrowers often use a 1099 mortgage program to buy their home. The term 1099 refers to the tax form that is used to report payments made to freelancers or contractors to the IRS. It’s a tax document, but it’s different than the more traditional W-2.
If the potential homebuyer’s business has shown a loss for tax purposes in recent years, that would be a big red flag if they were trying to qualify for a Conventional mortgage or a government-backed loan. However, when using a 1099 home loan program, the buyer’s income isn’t calculated with gains and losses according to tax documents. It’s calculated in this case with an expense ratio on the 1099 form.
“It’s a huge benefit for someone who is self-employed to be able to qualify based on something other than their tax returns,” Duenas said. “Some self-employed borrowers may choose to go with a bank statement loan, but for others, a 1099 loan may be more advantageous. What’s key is having all these tools at their disposal through a lender like Fairway, who can compare loan programs to find the one that fits each borrower, rather than trying to fit each client into the lender’s preferred program as their only option.”
You might hear this type of non-QM loan program referred toas either “asset depletion” programs or “asset utilization” programs. Just be aware, those terms mean the same thing.
An asset utilization program is similar to a bank statement loan in many cases, but the loans aren’t reliant upon how the potential borrower’s business functions. Asset utilization programs are often used by borrowers whose assets are highly liquid. Those liquid assets can be calculated as if in place of monthly income, allowing them to be able to qualify for financing based, not on what they make each month, but on how much of those liquid assets would be eaten up or “depleted” each month by paying off the home loan.
DSCR loans are often the best choice for real estate investors, with requirements that the borrower use the property as a rental property. DSCR loans consider the potential cash flow from the investment property, dividing the loan principal, interest, taxes, insurance and association dues (if applicable) by gross estimated rent to figure out the debt-service coverage ratio of the property. If that ratio meets the mark for qualification based on one of the loan programs Fairway makes available to its borrowers, the loan moves forward in the approval process with no reliance on the buyer’s debt-to-income ratio or income documentation. This is a huge benefit for borrowers looking to invest in real estate.
Some DSCR loan programs are specifically tailored to more experienced investors, while other DSCR programs are specifically aimed at bringing in first-time investors.
The non-QM mortgage space may offer the best path back to homeownership for borrowers who have gone through a derogatory credit event in the past. If they are on their way back to better credit, there are certain loan products that allow them to own a home again, with shorter seasoning periods than qualified mortgages allow.
What’s a seasoning period, you ask? It’s simply the amount of time that needs to pass between a specific financial event and the next specific financial event — in this case, since a derogatory credit event occurred and when a buyer can buy again. Derogatory credit events range from having a payment 30 or more days late in the last year all the way to bankruptcies and foreclosures. With qualified mortgages, borrowers may face a four-to seven-year seasoning period in some cases. However, in the non-QM space, Fairway has access to loan products that may be able to shorten that seasoning period to two or three years in many cases. That’s major relief to a potential homebuyer looking to get back into the market.
In this case, we’re describing a set of potential buyers rather than naming a type of loan programs. Buyers who carry an Individual Taxpayer Identification Number rather than a Social Security number could benefit from certain loans that Fairway has access to. Usually, these buyers are foreign nationals.
Terms for these mortgages can be 15, 30 or even 40 years, just like many other loans. There are adjustable-rate options as well as fixed-rate options. The passport information of the applicant will be key to start the process. The passport must be valid for a set number of years and/or months at the time of purchase, and if it is set to expire before the required date, the potential buyer would need to show proof of intent to renew. Several other criteria must also be met, but the main point is that these types of loans are specifically written to meet the needs of qualified foreign nationals who wish to purchase a home in the U.S.
Sometimes you will hear certain non-QM loan programs referred to as a “high-DTI” loan or an “interest-only” loan. It’s important to recognize that these are not loan programs themselves; these are features that may be added onto any one of several of the above non-QM loan programs.
Usually, a non-QM loan program will hold more stringent debt-to-income (DTI) requirements as part of the qualification calculations. This is because the rest of the loan parameters are generally thought to be riskier than the average qualified home loan; the more stringent DTI requirements are in place to protect the lenders who take on such loans. However, some non-QM programs also offer a high-DTI option within a bank statement loan or a 1099 loan program, for instance. They’re custom built to fit the borrower’s unique financial situation, but again, this added flexibility comes at a cost, usually in terms of fees or interest rate over the life of the loan.
“Interest-only” means that the loan doesn’t require the borrower to pay down any of the loan principal balance for the first several years of the loan term. Instead, during that introductory interest-only period, the buyer just pays the interest that is accruing on the loan each month. It is also a feature that can be added onto several of the above non-QM loan types.
At Fairway, we’re proud of our reputation for looking for ways to get buyers approved — looking for ways to get to “yes” instead of looking for reasons that a loan won’t fund. The name of the game is “How can we get the loan done?” without having to hinder potential homebuyers based on traditional income requirements that might not fit everyone’s situation.
“Non-QM loans are here to stay — at least for a while,” Duenas said. “At Fairway, we’re always looking to add options to bring more potential homebuyers into the fold. We’re aggressively expanding our offerings to account for the millions of potential homebuyers out there who are trying to generate income on their terms, through every possible means. It’s as important to help these folks achieve the American Dream as it is to help the W-2 borrower.”
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