Qualified vs. Non-QM Loans

Qualified vs. Non-QM Loans

For anyone who has been through the mortgage process, the concept of qualifying for a traditional loan should be rather familiar. Mortgages, including non-qm loans, are regulated at both the state and federal levels and require a considerable degree of transparency and standardization.

The regulations that govern traditional qualified mortgages are meant to serve roughly the same function as the accredited investor rules. Lenders are not permitted to write loans for borrowers who do not meet certain basic criteria. Among these are the ability to repay. Determining this ability often has to do with income verification, evaluating creditworthiness and various other requirements.

When borrowers venture outside the traditional market, there are still loans to be found, but they may or may not resemble the familiar mortgages we’ve all encountered before. So what exactly is the difference between a qualified and a non-qualified mortgage?

The Rules

It might surprise the average borrower to learn the qualified mortgage rule wasn’t adopted until 2014. The Consumer Financial Protection Bureau created the rule in order to protect homeowners after the financial crisis of 2008. Qualified Mortgages are required to comply with four basic regulations.

Borrowers must have the documented ability to repay. Some loans may not have risky features like balloon payments or interest-only payments. There are caps on fees and borrowers must be devoting an approved percentage of their income to housing. These rules prevent defaults, which benefits both borrower and lender.

The Exceptions

Some might contend, with considerable justification, that any loan that can’t be called a “qualified mortgage” is by definition sub-prime. Since many of these loans are made after traditional lenders deem the borrower too risky, the comparison isn’t necessarily off the mark. Ultimately, any loan that doesn’t meet the criteria for a qualified mortgage is, at the very least, a non-qualifying mortgage.

Borrowers in the “non-QM” category are evaluated with what lenders call “alternative criteria.” They are often unable to document their income or prove that a sustainable portion of their income is going towards their housing costs. This puts them at risk of overborrowing, but it also puts them in a position where they can’t work with a traditional lender, even if they do eventually repay what they borrow.

The Borrowers

At the top of the list for non-QM loans is the entrepreneur. Self-employed individuals often find their finances are adequate but documented in ways that traditional lenders don’t prefer. They will often end up paying higher interest rates. They will still have to comply with the alternative criteria offered by their non-QM lender. They will also often comprise the majority of non-traditional borrowers.

As with any product, if there is a demand, a supply will emerge, even in a tightly regulated market like home loans. That said, lenders must make every effort to avoid defaults, as those can be far more expensive than missing out on the sale in the first place. The non-QM market is one way such lenders are protecting themselves and their borrowers. What do you think? Leave a comment below and join the conversation.