You might have enough money for a down payment on a house but still struggle to qualify for a conventional mortgage instrument. In some cases, you might have better luck obtaining a non-QM loan (short for non-qualified mortgage), which could help you get the financing you need to purchase property for a primary residence, second home or investment.
The world of non-QM loans is expansive, and it has experienced its fair share of misconceptions, especially in light of the interest rate landscape brought about by the pandemic. In this article we cover what exactly are non-QM loans, how do they work, and whether they align with your needs when purchasing a new property.
What Are Non-QM Loans?
Traditionally, you qualify for a home loan by providing a bank, credit union, or other traditional lender with your financial information, such as your W-2s, tax returns, paystubs, and so on. A "non-QM" or non-qualifying mortgage is an alternative type of mortgage loan that lets you qualify with alternative methods (as its name suggests).
For instance, a non-QM loan allows you to qualify using alternative methods, such as bank statements or counting your assets as income. In other words, non-QM loans offer greater flexibility when compared to conventional mortgage options, expanding the possibilities for homebuyers and real estate investors.
It's important to note that non-QM mortgage loans don’t use the same qualifying criteria or factors that traditional loans do. As a result, non-QM loans are not required to meet federal government or Consumer Financial Protection Bureau guidelines for qualified mortgage loans, as they aren’t automatically classified as CFPB-qualified mortgages.
However, this flexibility also implies that non-QM loans may carry higher inherent risks compared to conventional loans. But don't dismiss them outright, as they can still be valuable under certain circumstances. If you don’t get tax returns or you have a foreclosure on your record, it can be difficult to convince mortgage lenders that you’re worthwhile (even if you’re trying to refinance).
A non-QM mortgage might be further ideal if you are seeking out homeownership but have a higher debt-to-income ratio (DTI), have a credit score below 620, or you need a loan amount that exceeds conforming loan limits.
What Are Some Non-QM Loan Options?
Depending on your needs and the assets you have to show to a lender, you might qualify for one or several non-QM loan options. Let’s take a closer look.
1. Bank Statement Loans
Bank statement loans are exactly what they sound like: loans you qualify for based on your bank statements. These are popular and favorable choices for self-employed borrowers if they aren’t able to verify all their income, if they have a non-traditional income, or if they have very high tax deductions.
Bank statement loans are perfect for small business owners and entrepreneurs, freelancers, lawyers, etc. To qualify, you have to provide between 12 and 24 months’ worth of bank statements to a non-QM lender to show the borrower’s ability to pay, and you typically need a credit score of 620 or above. On the bright side, your down payment could be as low as 10%.
2. Jumbo Loans
Jumbo loans are any mortgage loans that exceed loan limits set by Fannie Mae and Freddie Mac (called the conforming loan limit). In 2023, the conforming loan limit in Florida is $726,200 — thus, any mortgage loan that exceeds this amount is a “jumbo loan,” regardless of its other attributes.
In any case, jumbo loans are perfect options for borrowers who are in markets for luxury or high-priced homes or who wish to invest in very expensive real estate markets. Your down payment can be as low as 20%, but you need a credit score of 680 to qualify. That said, you may not need income verification (via something like pay stubs) or credit score benchmarks if you want to purchase an investment property.
Many borrowers use jumbo loans for investments, primary homes, vacation homes, and more.
3. Portfolio Loans
Portfolio loans are mortgages that lenders retain on their balance sheets rather than selling the loans on the secondary market (a traditional strategy that many conventional lenders follow to make profits). As a result, a lender for a portfolio loan can set their own lending requirements, work with borrowers more directly, and offer more flexible underwriting solutions.
Portfolio loans are often used by real estate investors who wish to work with exclusively local lenders who understand the intricacies and unique aspects of smaller, more focused real estate markets. Portfolio lenders usually focus on the quality of assets available to the borrower rather than their income history and credit; therefore, they don't require you to have credit history in the U.S., making it a good option for international investors. However, they do have a max LTV or loan-to-value ratio of 65%.
These might be excellent non-QM loan options for real estate investors who want to finance land, commercial, or residential real estate purchases, as well as condotel and non-warrantable condo investments. However, they aren't good choices for primary residence purchases or vacation home purchases, as this product is tailored for non-owner occupied assets.
4. Foreign National Loans
Foreign national loans are meant for foreign investors who want to buy a second home or investment property in the US. They require a valid visa, and minimum down payments hover around 25%.
Furthermore, with a foreign national loan, non-U.S. citizen can use their income earned overseas to meet the qualifications for a mortgage loan in the United States. In many instances, having an established credit history within the U.S. is not a mandatory requirement to get approved.
5. No Income DSCR Loans
No-income DSCR loans are meant for rental investors who want to use their properties' cash flow to help them qualify for mortgages. Specifically, such loans leverage the debt service coverage ratio or "DSCR" for lenders to verify if the property generates enough income to cover debt payments.
These loans usually require a credit score of 640 or more and a 20% minimum down payment. In most cases, a DSCR loan also requires you to own a primary residence as well.
What Are the Benefits of Non-QM Loans?
With so many different types of non-QM loans to choose from, you’ll find that these loans also offer a variety of critical advantages and benefits. These include:
They require different documentation and records compared to conventional loans, which again opens up their accessibility and makes them more flexible financing options for non-traditional investors.
They’re stellar options for self-employed individuals like freelancers or entrepreneurs. These professionals often don’t have the same documents and tax forms as more traditionally employed prospective homeowners.
They are also excellent for foreign nationals, who may lack the documents and income records needed to qualify for a mortgage in the US via traditional channels.
In many cases, non-QM loans are easier to qualify for compared to conventional loans that abide by the conforming loan limit. Of course, this is offset by the relatively higher risk compared to conventional loans!
Many non-QM loans are also available with 3/1, 5/1, 7/1, and 10/1 ARM options. With such a large variety of adjustable-rate mortgages, it’s more than possible to find a non-QM loan that works perfectly for your unique financial situation and investment limitations.
What Are the Drawbacks of Non-QM Loans?
While non-QM loans could be beneficial, you also have to keep the potential drawbacks in mind. These include:
Many non-QM loans have higher interest rates, which helps compensate the lenders for the higher-than-average risk they take on when they underwrite these loans. This follows logically; after all, if a mortgage loan is easier to qualify for, more people will qualify for it, so the lender has to increase the interest rate to compensate.
Some non-QM loans may also come with extra strings attached, like fees, types of payment schedules, short terms, and so on. It’s vitally important to read the terms and conditions of any non-QM loan you choose to sign — the last thing you want is to get into business or investment with a bad lender or a less-than-reputable partner.
While non-QM lenders offer more flexibility to get approved, they still have requirements and lending standards that borrower's need to adhere to that demonstrate their ability to repay the loan.
What Are Some Alternatives to Non-QM Loans?
Although non-QM loans may seem like your only option, it’s important to keep alternatives in mind for your real estate investment or primary home purchase.
For example, conventional loans are popular American mortgage instruments for good reason: they are secure and reliable. If you can qualify for a conventional loan, there’s no real reason to opt for a non-QM loan (e.g., you have a good credit score, good income, and other required documentation).
You can also pursue FHA or VA loans. Both of these come from the Federal Housing Administration or the Department of Veterans' Affairs, respectively. In either case, mortgage loans from the FHA or VA have lower interest rates and lower down payment requirements, though they do have stricter qualification requirements regardless. However, FHA and VA do have some restrictions in exchange for easier qualifications.
For example, you have to be a veteran or the spouse of a veteran to qualify for a VA loan. Additionally, an FHA loan can only be used to purchase a property you plan to live in. This means it cannot be used to purchase a second home or investment property. The exception to this is if you buy a multifamily unit where you live in one of the units and rent the other units.
If you are looking for alternative financing to purchase an investment property, consider a private, bridge, or business-purpose loans. Private loans, including bridge loans, come from local private lending firms. Private bridge loans are short-term loan instruments meant to help you purchase a property quickly until long-term financing can be put in place. Private bridge loans are an ideal solution for borrowers who need a fast infusion of capital to avoid a purchase deal falling through that cannot wait 45 days for a conventional loan approval.
The Bottom Line
All things considered, it's important to explore all of your mortgage options to ensure you land on a solution that meets your needs adequately. A good starting point is to work with a loan professional that can assess your situation and put the best options in front of you — contact us today to connect with a Vaster loan specialist.