Here’s a common scenario: You have the income necessary to pay a mortgage, but you’re self-employed and the bank won’t accept your quarterly profit-and-loss statements as proof of your income. Plus, they say your historical income shown on your tax returns doesn’t speak to your income right now, and how do they know if you’ll have that income in the future?
Given the state of the economy and the fact that even well-paying jobs with major companies can disappear overnight, it seems arbitrary and a little silly that you can’t get a traditional mortgage – but that’s often what happens. You know that you can pay a monthly mortgage on time and you’re ready to get out of the rental trap, but how do you convince the bank to give you a loan?
You probably can’t. However, there’s a category of loans known as Non-Qualified Mortgages (Non-QM), which may be worthwhile exploring. If you’re self-employed or have other issues that might prevent you from obtaining a traditional mortgage, here are some things you need to know.
What is a Non-Qualified Mortgage (Non-QM)?
A Non-QM loan is a type of mortgage that doesn’t conform to the stringent requirements established by the Consumer Financial Protection Bureau (CFPB) and the Dodd-Frank Act. These requirements were put into place shortly after the 2008 housing market crash to avoid a repeat of the events that led to some disastrous free-wheeling lending and borrowing.
When you apply for a qualified mortgage, you have to show a documented source of regular income, e.g., your paystubs, as well as needing to meet certain credit score requirements and debt-to-income ratios to qualify.
The primary aim of QM rules is to ensure that borrowers have the ability to repay their loans, reducing the risk of default and foreclosure. Non-QM loans, on the other hand, deviate from these guidelines, providing more flexibility to lenders and borrowers.
Non-QM loans can be broken down into several subtypes, each tailored to address the unique needs of different borrowers. Some examples include:
- Interest-Only Loans: With an interest-only loan, you pay only the interest portion of your mortgage for a specified period, typically between five to ten years. This option may appeal to you if you anticipate a significant increase in your income in the near future or expect to sell the property before the principal payments begin.
- Asset-Qualifier Loans: These loans consider your liquid assets as a source of income to determine your ability to repay the mortgage. This can be useful if you have retirement accounts or investment accounts that you can draw on, should the need arise.
- Bank Statement Loans: These loans base your monthly income on your bank statements, not your tax returns. If you’re self-employed, this can be ideal, since deductions and other tax mitigation strategies mean that there’s often a big difference between the money you earn and your taxable income.
These are not the only Non-QM loans available, but they do give you a good idea of what might be out there.
What Kinds of Borrowers Should Consider Non-QM Loans?
There are several scenarios where a Non-QM loan could be the best (or only) option for potential homeowners:
- You’re Self-Employed or a Gig Economy Worker
As mentioned before, self-employed people often have a tough time getting through the underwriting process to obtain a conventional (qualified) mortgage. The banks want you to provide them with the kind of income verification documents you simply don’t have because you’re a freelancer, a consultant or an entrepreneur.
- You Have a High Debt-to-Income Ratio
Ideally, lenders like to see a debt-to-income ratio that’s below 36% before they’ll approve you for a traditional mortgage, but what if you’re just a little bit above that amount? Some lenders may take a chance on you (although you’ll probably be slapped with a higher interest rate), but many will not. If you have student loans, for example, that could negatively affect your debt-to-income ratio even if you’re on an income-based payment plan or have deferments, making a Non-QM loan your best option.
- You Have Had Major Credit Issues in the Past
You’ve been through bankruptcy – but so has roughly 11.1% of the current U.S. population, so why should that stop you from obtaining a mortgage? Now that your debt burden from the past is gone, you have more ability than ever to afford a home loan, but the bank may not see it that way if your bankruptcy was recent. Some Non-QM lenders will allow you to qualify for a loan as soon as your bankruptcy is discharged.
- You Are a Foreign National or Lack a Credit History
Non-QM loans can be an option for foreign nationals or others who, for whatever reason, don’t have a credit history. Traditional mortgages require a U.S. credit history and may be challenging for those who have recently moved to the United States or those who simply never used credit before.
- You Just Got Your Career Started
Maybe you just got out of college and are making plenty of money to afford a mortgage, but this is your first real job in your chosen profession. Typically, regular lenders like to see a two-year work history before they’ll consider your position “secure enough” to give you a loan.
There may be other, similar circumstances in which a Non-QM loan is your best chance for buying a home.
What Are the Drawbacks of Non-QM Loans?
While Non-QM loans offer tons of flexibility, they do come with certain drawbacks that borrowers should consider. These include:
- Higher Interest Rates: Non-QM loans typically carry higher interest rates than QM loans. This compensates lenders for the increased risk associated with providing mortgages without any government backing.
- Limited Availability: These loans involve more risk for lenders, so not all financial institutions choose to offer them. You may need to do some research to find the best deal and work with specialized lenders.
- Higher Down Payments: You may be required to come up with a bigger down payment – possibly as much as 20% – to secure a Non-QM loan, which is substantially higher than what most conventional lenders require.
Keep in mind, that if you’re leery of Non-QM loans, there are several alternative programs you might want to explore. FHA loans, for example, have more relaxed credit requirements and down payment options than traditional mortgages. VA loans are available to eligible veterans and military service members, while USDA loans help borrowers in eligible rural locations buy homes without substantial down payments.
Non-QM loans serve as an important alternative for borrowers who don’t fit within the strict criteria required for conventional mortgages. They provide the flexibility necessary to make homeownership possible for a wider range of people – but they aren’t ideal for everyone. Working with a knowledgeable mortgage professional can help you navigate your choices.