In 2011, the federal government passed the Dodd-Frank Wall Street Reform Act and created the Consumer Financial Protection Bureau (CFPB) to protect consumers. The CFPB put in place standards and rules for mortgage lending. These standards divided home loans into qualified mortgages (QM) and non-qualified mortgages (Non-QM).
To best explain what a Non-QM mortgage is, it’s helpful to look at a brief overview of the guidelines for QM loans.
WHAT IS A QUALIFIED MORTGAGE
The CFPB established the QM guidelines so that mortgage lenders ensure consumers can afford – and repay – their loans. The guidelines prohibit certain loan features, such as loan terms longer than 30 years, prepayment penalties, balloon loans, and loans with negative amortization.
Also, for QM loans, lenders need to review specific documentation, like copies of paystubs, W-2s, and tax returns to verify income and bank statements for asset verification. Reviewing these documents proves the lender made a “good faith effort” to determine the borrower’s ability to repay the loan before it’s made.
As a part of the ability-to-repay rule, a debt-to-income (DTI) ratio is utilized. DTI is the portion of gross monthly income that will repay debt, including the total mortgage payment. There are no exceptions allowed for this or any other QM qualifying guideline.
Mortgages that vary from the QM guidelines set by the CFPB fall into the Non-QM category.
WHAT IS A NON-QM MORTGAGE?
Lenders offering Non-QM loans also start by focusing on the borrowers’ ability to repay. They consider a borrower’s income stability and employment history, credit history, asset position, and the property used for collateral. But, with Non-QM loans, there’s a greater variety of loan programs – and more flexible documentation guidelines.
Compared to the vanilla QM programs, Non-QM loan programs offer:
- Loan terms with amortizations up to 40 years.
- Interest-only payments for adjustable and fixed-rate mortgages.
- Investor loans
- Loans to foreign nationals
A loan program is not a QM if it includes one of the above features. But even a 30 year, fixed-rate loan can be considered a Non-QM if it’s underwritten using alternative documentation and more flexible guidelines. Those alternative documentation options are what make Non-QM loan programs so valuable.
Plus, in a mortgage world that relies on automated systems to underwrite loan files, a Non-QM loan can be reviewed by an underwriter manually. Manual underwriting allows lenders to use alternative documentation and methods to evaluate income and assets.
And that’s great news for self-employed borrowers and individuals who experience monthly income fluctuations because of their industry or job type. For instance, individuals with sporadic income jobs may benefit from interest-only loans since a lower payment is helpful during times of the year when they’re earning less.
Extending the loan term from 30 to 40 years also allows a borrower to have a lower monthly payment. A lower monthly payment could make your dream home affordable, making the extended-term worthwhile. And you have the option of applying any additional income to the principal balance to shorten the loan term while keeping the payments affordable.
ALTERNATIVE DOCUMENT PROGRAMS
Using alternative documents instead of pay stubs and W-2s is an attractive feature of Non-QM loans. For anyone earning an income in a non-traditional way, qualifying for a mortgage might seem impossible. But the good news is, by using alternative documentation – it’s possible.
Take a look at these Non-QM alternative documentation programs. (Most programs require either a business license or a letter from a CPA confirming the business/employment):
Bank Statement Programs
For borrowers self-employed for a minimum of two years, Non-QM lenders can use bank statements to calculate qualifying income. These loan programs use 3, 12, or 24 months of personal or business account statements. Lenders determine income by using regular deposits from business proceeds.
Individuals working in the service industry, who earn cash tip income, can also benefit from income verification via bank statements. Any base salary they earn is verified with paystubs and W-2s, but the bank statements are used to verify and include their tip income.
A “1099 contractor” is also considered self-employed and eligible for the bank statement program. You will need to provide written confirmation from a CPA that you are a 1099 contractor and file either a Schedule C or Schedule E with your personal tax returns.
1099 and Profit & Loss Statement Programs
Another alternative documentation option for self-employed borrowers accepts a CPA prepared and signed Profit and Loss (P&L) statement for income verification. This is an excellent alternative to providing full tax returns.
With a minimum of two years of self-employment, borrowers can provide one full year and a year-to-date P&L as alternative documentation for this program. You’ll also need a letter from your CPA confirming they’ve reviewed or prepared the most recent two years of your tax returns.
What if your income is 100% commission-based? Then your 1099 is acceptable for documenting income with this loan program. Provide the previous years’ 1099 and pay stubs or bank statements to verify your year-to-date income.
Written VOE only program
Even if you’re a wage earner, you can use alternative income documentation to qualify. Instead of providing pay stubs and W-2s, there are Non-QM programs that allow a written verification of employment as the only income documentation required.
Asset Verification and Depletion program
If you’re not employed but rely on income from savings and investments, a Non-QM loan program allowing six months of asset statements for qualifying will work well for you. The assets can be in a bank account or invested in stocks, bonds, or mutual funds. You can even qualify with your retirement accounts.
Investor DSCR program
There are Non-QM loan programs that allow experienced real estate investors to qualify without using their employment or personal income. An investor “debt service coverage ratio” (DSCR) loan uses the cash flow from the investment property for qualifying.
Foreign National Program
Non-QM loan programs are also available for foreign nationals living or working in the U.S. or who frequently come here for vacation. These loan programs can’t be used to purchase a primary residence but work for purchasing rental or vacation properties. Instead of proof of U.S. income, credit, or a Social Security number, verification of assets and credit history from the individual’s home country are used.
If you can’t qualify for a mortgage based on standard QM underwriting guidelines, you may be a perfect fit for a Non-QM mortgage. With the alternative documentation options, a longer loan term, or the ability to make interest-only payments – Non-QM loan programs can open the door to your new home.