Yes, they’re not only important but necessary in the mortgage world. What’s a non-QM loan you ask? The answer is basically any mortgage loan that isn’t a QM loan. That makes perfect sense, right? But to understand the importance of a non-QM loan, we first need to understand what a QM loan is.
The Consumer Financial Protection Bureau, or CFPB, created a new set of lending guidelines following the mortgage troubles of 2008-2009. One of these, was creating the definition of a Qualified Mortgage. This is important because a loan that follows QM guidelines provides litigation protection from consumers who took out mortgage loans and found they couldn’t pay for them and went into foreclosure. Prior to this period, mortgage loans were issued with increasingly relaxed standards. First, credit score requirements were lowered. Later, documentation standards were nil, if any. The sub-prime mortgage market was robust.
Essentially, almost anyone could get qualified for a mortgage. So much so, that the concept of ‘flipping’ reentered the real estate vernacular. Because it was so easy to qualify, the housing market went white-hot. This newly created demand meant someone could buy a home and turn around and sell it 30 days later, if not sooner, for a profit. Yet we all know the end of that story, and it’s when the CFPB stepped in. As long as loan programs met these new QM guidelines, lenders could relax without worrying about lawsuits from borrowers in mortgage trouble. What were some of these guidelines?
One of the more important guidelines concerned affordability. QM guidelines required lenders to verify affordability by calculating debt ratios. This is referred to as the ‘ability to repay’ rule, or ATR. QM guidelines required a total debt-to-income ratio of 43. This simply means that the mortgage payment, including taxes and insurance along with other monthly credit obligations should not exceed 43% of an applicants total qualifying gross monthly income. If someone wanted to buy a home but their debt ratios are stretched to say 51, the loan would not qualify for the QM protections. Closing costs including fees and points could not exceed 3% of the final loan amount is another feature of a QM loan. So, where do non-QM loans come into play and why are they necessary in our industry?
First, non-QM loans are not subprime loans. Subprime loans are those that approve applicants that do not meet ‘prime’ guidelines. Prime guidelines can be a moving target but generally speaking a prime loan is one that does not cater to those with damaged credit. A non-QM loan is not reserved for subprime status. They can be based upon standard guidelines but in general, a non-QM loan typically does require minimum credit scores near the 620 mark, although individual lenders can insert their own internal credit requirements. What are some examples of available non-QM loans?
Perhaps one of the more popular non-QM mortgages is the so-called ‘bank statement’ loan. What’s that? A bank statement loan verifies income in a non-traditional way. Most loan programs ask for incomer verification to meet the ATR requirements. This means paycheck stubs, W2s and personal and business income tax returns. But with a bank-statement loan, income is verified in a different way.
A bank statement loan reviews months of recent deposits. While someone that gets paid on the 1st and 15th or every other week, for example, a bank statement loan shows deposits to verify receiving income from clients. Bank statement loans cater to the self-employed borrower. Self-employed borrowers rarely get paid on a regular, consistent basis. Instead, income is averaged over the last 12-24 months based upon client payments. A self-employed borrower sends out invoices, gets paid, and the funds arrive directly into the business bank account. Lenders look for these deposits and use the verified income that was received. An ‘interest only’ loan is one where the loan accepts minimal interest only payment each month without requiring a payment to the outstanding loan balance, or principal.
‘Balloon’ mortgages are those where the outstanding loan balance is due at the end of the initial loan period. A 5/1 interest only loan might accept interest only payments each month for a predetermined period of time. At the end of five years, the entire note comes due. Who would take out a loan like this? Typically, it’s someone that’s self-employed or gets erratic income. Rates for a 5/1 loan are typically lower than market rates. Those that plan on keeping the home short term can benefit from this program.
There are other non-QM home loans that can provide valuable benefits to borrowers. I have access to such programs that others may not have. If your situation might be an ‘outside the box’ issue, a non-QM loan just might be the answer.