Non-QM Trends

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Orion's brokers know that we offer a wide array of products. And even if we don't specialize in offering a certain product for our brokers, or originate very little of it, we like to track what is happening with it as an indication of the health of the overall market.

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Many potential borrowers are financially prepared to take on a mortgage but face challenges qualifying through traditional channels. For instance, self-employed individuals, gig workers, or retirees often lack W-2s or pay stubs to verify their income, which lenders usually require to assess a borrower’s ability to repay a qualified loan under the standards set by the Consumer Financial Protection Bureau.

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However, these borrowers still have options. Some lenders provide non-qualified mortgages, commonly known as non-QM loans, designed to accommodate those who don’t meet conventional lending criteria. These loans offer more flexible income and credit requirements but typically require borrowers to make a higher minimum down payment and accept higher interest rates in return.

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What is a Non-QM loan?

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Non-QM loans are a type of mortgage that operates under its own set of criteria, offering greater flexibility in income and credit requirements compared to traditional loans. These mortgages fall outside the standards established by the Consumer Financial Protection Bureau (CFPB) and, as a result, are not eligible for backing by Fannie Mae, Freddie Mac, or government agencies. In return for this expanded access to home financing, borrowers often face higher interest rates and larger minimum down payment requirements.

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One product that doesn't fall into the Qualified Mortgage category, namely non-QM mortgages. Currently the industry is commenting on a set of proposals issued by the CFPB slightly over a month ago, including a proposed extension to QM guidelines (“the GSE Patch”) and new definition of non-QM, much of which goes along with industry thinking. Given that it would appear that non-QM loans will account for somewhere between 1 to 5 percent of overall production, and the huge majority come from three states (CA, FL, and NY), plenty of lenders either don't care about the product or aren't even licensed in those states. And a large percentage of non-QM loans flow directly into the portfolios of credit unions and banks who often price it very competitively and like owning the asset. But it is still a good idea for Orion's brokers to see who is doing what, and what the trends look like.

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Non-QM loans: flexibility at a cost

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Non-qualified mortgages (non-QM loans) are designed for borrowers whose financial profiles do not align with the strict criteria of typical qualified mortgage loans. These loans provide an alternative path for individuals with inconsistent or nontraditional income sources, recent major credit events, or higher debt levels that would otherwise disqualify them from conventional mortgages.

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Key Features of Non-Qualified Mortgages

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Alternative Income Verification Methods: Unlike traditional loans that rely heavily on W-2s and pay stubs, non-qualified mortgages allow borrowers to demonstrate their ability to repay using alternative documentation. This can include tax returns, bank statements, asset-based qualifiers, or 1099 forms, providing flexibility especially for self-employed borrowers or those with multiple income streams.

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No Waiting Period After Bankruptcy or Foreclosure: Non-QM loans often cater to borrowers who have experienced recent credit setbacks such as bankruptcy or foreclosure. While qualified mortgage loans typically impose waiting periods ranging from one to four years after bankruptcy and two to seven years after foreclosure, non-qualified mortgages may offer approval as soon as one day after such events, helping borrowers regain access to home financing sooner.

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Higher Debt-to-Income Ratio Limits: Qualified mortgages generally cap the debt-to-income (DTI) ratio at 43%, limiting the percentage of income that can go toward monthly debt payments. Non-qualified mortgages, however, often allow for higher DTI ratios, sometimes exceeding 50%, accommodating borrowers with higher monthly debts.

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Increased Down Payment Requirements: To offset the higher risk, non-QM loans usually require a higher minimum down payment, typically between 15% and 20%. This contrasts with the average down payment for first-time homebuyers, which was around 8% in 2023, and 19% for repeat buyers, according to the National Association of Realtors.

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Higher Interest Rates: Non-qualified mortgages generally carry higher interest rates than qualified mortgage loans. While they offer more flexible qualification criteria, borrowers pay a premium for this flexibility, making non-QM loans a more costly form of home financing.

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Lack of Government Backing: Unlike qualified mortgages, non-QM loans do not conform to the Consumer Financial Protection Bureau’s (CFPB) standards and therefore cannot be purchased or guaranteed by government-sponsored enterprises like Fannie Mae or Freddie Mac. They are also not backed by government agencies such as the Department of Veterans Affairs (VA), the U.S. Department of Agriculture (USDA), or the Federal Housing Administration (FHA). This means the lender assumes full risk for the loan, which influences loan terms and pricing.

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Overall, non-qualified mortgages serve as a crucial option for borrowers who do not meet traditional lending requirements but are financially capable of managing a home loan. By offering alternative income verification methods, accommodating higher debt levels, and allowing quicker access after credit events, non-QM loans provide a flexible yet more expensive solution for home financing.

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Borrowers who may consider a non-QM loan

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The requirements tied to qualified mortgages aim to ensure borrowers can consistently meet their payment obligations. A non-QM loan might be the right choice if you’re confident in managing the necessary down payment and monthly payments, and if any of the following describe your situation:

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• You’re a contractor, self-employed, retired, or have non-traditional income sources that make standard income documentation difficult to provide.
• You’ve recently undergone a significant credit event, such as a foreclosure or bankruptcy.
• You’re a landlord looking to leverage the cash flow from your income-generating properties to qualify for a new home loan.
• Your debt-to-income ratio exceeds 43%, meaning a larger portion of your income goes toward monthly debts.

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Non-QM pros and cons

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Non-QM loans provide an opportunity for non-traditional borrowers to finance their homes. This includes:

• Retirees
• Real estate investors
• Self-employed individuals or gig workers
• Borrowers with a high debt-to-income ratio
• Borrowers with credit blemishes

These loans rely on alternative documentation to make home financing possible.

The Consumer Financial Protection Bureau (CFPB) sets standards to assess a borrower’s ability to repay a mortgage. Typically, lenders require documents such as:

• W-2s
• Bank statements
• Pay stubs
• Tax returns

However, Non-QM loans allow qualification using alternative documents like 1099s, profit and loss statements (P&L), written verification of employment (WVOE), bank statements, and rental income.

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Drawbacks of Non-QM loans

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Because Non-QM loans do not adhere to traditional guidelines, they cannot be purchased by Fannie Mae, Freddie Mac, or backed by government agencies such as the FHA or USDA.

As a result, lenders assume full risk when issuing Non-QM loans. To compensate, these loans often carry higher interest rates than conventional loans, which can increase your monthly mortgage payment.

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Non-QM loan requirements

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The exact criteria for a Non-QM loan vary depending on the specific program, but generally, Non-QM loans provide greater financial flexibility compared to traditional mortgages.

• Credit History
• Non-QM loans often accommodate borrowers with less-than-perfect credit. Many programs accept credit scores as low as 620, and some even open the door to homeownership for individuals with scores around 500.
• Debt-to-Income Ratio
• While conventional loans typically require a debt-to-income (DTI) ratio of 43% or less, Non-QM loans may allow DTIs of 50% or higher. This makes home financing accessible to borrowers whose existing debts might otherwise disqualify them.

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Where to Find Non-QM Loans

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Non-QM loan programs are often customized to meet the unique needs of different borrower profiles. To find options that suit your financial situation, research lenders who specialize in non-QM loans and review customer feedback relevant to your circumstances.

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For instance, if you’re seeking non-QM loans due to a recent credit challenge, consider checking lender lists such as NerdWallet’s Best Mortgage Lenders for Low or Bad Credit Score Borrowers, which features several lenders offering non-QM loan products.

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Alternatives to non-QM loans 

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Non-QM loans aren’t suitable for everyone, especially if your financial situation cannot accommodate a higher minimum down payment or increased interest rates. However, even if you are a non QM loan borrower with non traditional income sources or non salaried income, you may still qualify for a qualified mortgage loan.

• According to Fannie Mae’s guidelines, self employed borrowers or independent business owners may qualify for a qualified mortgage by providing two years of individual and sometimes business tax returns.
• Reducing your existing debt or lowering your interest rates through a debt consolidation loan can improve your debt to income ratio, helping you meet traditional lending requirements and qualify for conventional loans.
• If you experienced a distressed property sale such as foreclosure due to a qualifying financial hardship, you might be eligible for a waiver of the typical waiting period. This requires documentation and evidence of financial recovery, such as resolving medical debts or divorce-related expenses.

These alternatives may allow you to secure a traditional mortgage or VA loans despite previous credit challenges, improving your financial literacy and access to home financing options.

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The Bottom Line

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A non-qualified mortgage can provide a pathway for unconventional borrowers to secure loan approval. However, even with a non-qualified mortgage, certain requirements remain: you must demonstrate your ability to repay the loan, and after signing your loan agreement, you’ll need to make consistent, timely payments over the life of the loan. If a non-qualified mortgage allows you to purchase a home on terms that suit your financial situation, it can be a valuable option. But if it risks stretching your finances too thin, exploring alternative financing solutions might be wiser.

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Regardless of whether you choose a non-qualified or traditional mortgage, maintaining good credit is essential to obtaining the most favorable interest rates and loan terms. Take advantage of free resources to check your credit report and credit score, and access useful advice to help improve your credit standing.