How they work, advantages and disadvantages
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- A non-qualifying or non-QM loan does not meet the Consumer Financial Protection Bureau’s requirements for qualifying mortgages.
- These mortgages can help those with unusual financial situations or difficult credit histories to buy a home.
- But they are usually much more expensive than traditional mortgages and carry a higher risk of default.
Following the Great Recession, the mortgage industry was forced to tighten its lending standards to avoid another subprime mortgage crisis.
The fact that lenders are held to higher standards to ensure their borrowers can afford the mortgages they get is generally a positive development. But the stricter guidelines mean some borrowers – such as the self-employed or gig workers – find it difficult to meet the requirements to qualify for a traditional, compliant mortgage, even if they can afford to take on the ready.
Non-conforming loans, often referred to as non-QM loans, are a type of mortgage that some lenders offer to help these types of borrowers qualify for a loan. But they are often expensive, both initially and in the long run.
Your estimated monthly payment
- pay one 25% a higher down payment would save you $8,916.08 on interest charges
- Lower the interest rate by 1% would save you $51,562.03
- Pay an extra fee $500 each month would reduce the term of the loan by 146 month
What is a non-QM loan?
A non-QM loan is a mortgage that does not qualify to be considered a qualifying mortgage.
“Non-QM loans are a solid alternative to conventional financing, but they come at a price,” says Joshua Massieh, CEO of Pacwest Funding in San Diego and contributor to The business brotherhood channel on Youtube. “There are several types of home loans that fit into the non-QM bubble, and they’re generally designed for people who are self-employed or just don’t fit into the conventional lending category.”
Some non-QM loans allow for alternate methods of approval, while others cater to those who have negative events on their credit reports that prevent them from qualifying for a regular mortgage.
Who are non-QM loans suitable for?
For borrowers who can afford a mortgage but have an unusual financial situation that makes it difficult to get a qualifying mortgage, a non-QM loan can make home ownership possible.
“In some cases, it’s a borrower with a short credit history or a job in the working economy whose income comes from Paypal, Venmo and other sources that aren’t always associated with stubs. regular payroll,” says Suzanne Ross, Mortgage Product Manager at Ocrole.
A popular type of non-QM loan is a bank statement loan. With this type of mortgage, the borrower provides bank statements to prove income, rather than the standard tax documents that lenders use for qualifying mortgages.
“A bank statement loan can be an advantage if the borrower’s tax returns don’t accurately reflect their income,” Ross says. “For example, a borrower whose tax returns reflect less income than actually earned due to business expenses and deductions taken.”
Some lenders also offer non-QM loans to borrowers who have recently had bankruptcy, foreclosures, or other negative events on their credit reports. For example, you will usually have to wait seven years after a foreclosure to qualify for a traditional loan, but some non-QM loans may not have a waiting period at all.
Non-QM loans can also be beneficial for investors who wish to use cash flow from the properties they purchase to qualify.
Advantages and disadvantages of non-QM loans
Non-QM loans can be useful if you don’t qualify for another type of mortgage, but they are often expensive and can be risky.
Non-QM loans are more expensive than traditional mortgages, both upfront and long term. You’ll likely pay higher closing costs due to the increased cost of points and fees that often come with a non-QM mortgage, and you’ll likely get a much higher rate than you’d get with a traditional mortgage.
You should also consider the risk that you may not be able to repay the loan. If your finances are fragile or the loan has expensive features, you could find yourself in default.
Is a non-QM loan a conventional loan?
Conventional loans are mortgage loans that are not guaranteed by a government agency. Non-QM loans technically fit this definition, but when most people talk about conventional loans, they are referring to conforming loans. Conforming loans are a type of conventional loan that follows Fannie Mae or Freddie Mac guidelines.
Conventional and conforming loans are generally more affordable than non-QM loans. So if you are able to get one, you should get a conforming loan rather than a non-QM loan.
“Generally, conventional loans come with lower down payment requirements, interest rates are typically 2-3% lower than a non-QM loan, and a conventional loan will cost you less to get,” says Massieh.
Even if you think you might not qualify for a conforming loan, it’s worth talking to a lender and seeing what your options are. Being self-employed, for example, does not automatically prevent you from obtaining a conforming loan.
“Many borrowers are eligible for conventional financing, even with irregular or non-traditional incomes,” Ross said.
Are non-QM loans safe?
Some non-QM loans may have certain risky features that are not permitted on qualified mortgages. According to the CFPB, this could include:
- Interest only periods, during which the borrower only pays interest, which means that he does not repay the principal of his loan.
- Negative damping, where the loan principal increases over time. This happens when your payments are not enough to cover the interest on the loan, so they are added to the principal.
- Lump sum paymentswhich are payments due at the end of the loan that are much larger than your regular monthly payment.
- Terms over 30 years
If you’re considering getting a non-QM loan, make sure you understand all the terms and conditions that come with it, and that you can afford it now and for the life of the loan.