Alternative Money: Using Non-QM Loans to Buy a House

What is a Non-QM Loan?

First things first, the basics.  A Non-Qualified Mortgage Loan (non-QM Loan) is a loan issued by banks and private lending institutions to individuals who do not meet traditional lending requirements.

Non-QM Loans are, essentially, property loans that do not follow the rules issued by the Consumer Financial Protection Bureau (CFPB) on qualified mortgages.  So they can allow alternative forms of income, adjust amortization periods, and even allow higher debt limits.

Non-QM loans have more flexible income and credit requirements. However, this does not mean any and everyone can apply for a non-QM loan and get one.  These kinds of loans are not backed by the government so all of the risk is born by the issuing institution.  So, naturally, there are still requirements that you must satisfy in order to receive a loan.

Who are Non-QM Loans for?

Non-qualified mortgage loans are for people who do not qualify for loans from a traditional lending institution. These include people such as:

• Freelancers / self-employed gig workers
• Retirees
• Expats (who have been making money abroad)
• Foreign Nationals
• Real Estate Investors (whose income is from their rentals)
• People with a lot of debt
• People with bad credit
• People with a recent Foreclosure
• People who recently filed for Bankruptcy
• and anyone who does not have traditional income structures and whose income may fluctuate

What are the Benefits of Non-QM Loans?

There are numerous benefits to getting a non-QM loan.  The main perk being it provides options.  Options that people who don't qualify for traditional loans can take advantage of.  That means, even if you have bad credit you could potentially receive a mortgage to buy your dream house!

Here are some other pros of Non-QM Loans:

Flexible Income and Credit Requirements

With traditional banks, you would need to submit W2s and tax returns as proof of your income and thus, your ability to repay your loan.  But if you're a gig worker who receives a 1099, then getting a traditional loan just won't work.

Luckily, with non-QM loans, you can use your 1099s, profit and loss statements, and even your bank statements to help you qualify for a loan.

And when it comes to credit, non-QM loans offer the most flexibility.  There are some institutions where you can have a credit score as low as 500 and still qualify for a loan!  

Alternative Documentation for Income

Here are the various forms of documentation you can use as proof of income for Non-QM Loans:

• Bank statements
• Profit and loss statements
• 1099 statements
• Your Assets (retirement accounts, brokerage accounts, etc)
• Rental receipts, leases for investment properties
• Other documents (Written Verification of Employment, etc)

Increased Amortization Periods

For traditional loans, the maximum mortgage term is 30 years. However, with non-QM loans you can extend it up to 40 years. This would decrease your monthly bill, which means more money that you can keep in your pocket each month.

However, the downside to this is it will cost you in that you will pay more overall for your house, as that is 10 more years  of accumulating interest.

No Waiting Period After Bankruptcies / Foreclosures

Typically, if you file for Chapter 7 or Chapter 11 bankruptcy, you'd have to wait any where from 1 - 4 years before you could apply for a home or property loan.  And if you've had a recent foreclosure, you'd need to wait 3 - 7 years before you can apply for a loan.

However, with some non-QM loans (depending on the institution) there is no waiting period.  Yes, you read that right. Absolutely none. You're welcome. 

Higher Debt Limits

For the typical home loan, banks require a maximum debt to income ratio of 43%.  With non-QM loans, they will allow up to 50% debt to income ratio.  This gives even those with high debt amounts the chance to receive a loan to purchase a property.

What are the Downsides of Non-QM Loans?

As the saying goes, everything that glitters isn't gold.  And the same holds true for non-qualified mortgages.  While it can sometimes be a blessing that these non-QM loans don't follow the CFPB, the downside is that it means there are less protections for you, the borrower.

Higher Interest Rates & More Fees

For starters, non-QM loans are more expensive than their traditional counterparts.  (Remember, these loans aren't backed by the government.  These companies are taking on higher risks so they will want higher returns.)

The interest rates for non QM loans tend to be 1 - 2% higher than the rates of traditional banks.  This may not seem like much now but in time those additional percentage points add up.  So be sure to keep this in mind when considering your options.

Furthermore, while the CFPB caps the fees that a bank can charge to 3% of the loan amount (for $100k+ loans), non QM loans have no such rule to follow. Thus, their upfront fees tend to be higher.

Higher Down Payments

If the down payment is already a pain for you, that pain will only get bigger with Non-QM Loans.

While you could potentially only put down 3.5% as a down payment on your first house with a traditional loan.  With a non-QM loan, your down payments typically fall between 10% and 25% but they can go higher.  Of course, the lower your credit score the higher your required down payment will be.

Interest Only Repayment Plans

Another thing to watch out for are lending practices that have been known to bite the borrower in the butt.  This includes things such as "Interest Only Repayment Plans".  

I know they say never say never but in my opinion, you NEVER want to go this route.  An interest only payment plan is setting yourself up for failure.  Doing this, makes you more likely to default on your loans.  (One of the many reasons for the 2008 market crash).  Not to mention, that all the while you are paying on this loan, you won't be building up any equity, which is one of the main reasons to invest in real estate.

One More Thing

You should also watch out for negative amortization schemes, where your loan amount actually increases over time, and balloon payments, where a large lump sum payment is due at the end of the loan term.  These are also problematic for most borrowers.

Biting Off More Than You Can Chew

When it all comes down to it, the biggest downside of a non-QM loan is the fact that, in taking out this loan you might be taking on more than you can handle financially at the moment.

The rules put in place by the CFPB were put there for a reason.  And that is to protect you, the borrower.  Without the protections of the CFPB, borrowers are more at risk of defaulting on their loans.  That's way, it is important for you to understand what you are getting into when applying for these loans.

Where Can I Apply for a Non-QM Loan?

There are many institutions that can assist you in applying for a Non-QM Loan.  With just a quick Google search many will appear.  However, each place will have their own standards and requirements.  

For some a credit score of 500 will be okay, but for many others, the minimum is 620.  While some may only offer 30 year loans, others may offer up to 40.  It all depends on the institution.  So take your time and search for the best option for you.

What to Do If You Still Want to Go the Traditional Route?

If, by now, you have determined that Non-QM Loans are not for you, that is okay.  Non-QM loans are not for everyone.  And even if you don't qualify for a traditional bank loan right now, there are steps you can take to increase your chances of qualifying.

Are you self-employed?

If you are a freelancer or gig worker with income not written on W2 forms, you could still qualify for a traditional loan by showing 2 years of tax returns.  Yes, this means if you are just starting out then you will have to wait a few years to apply.

Do you have too much debt?

One big issue that many people face when trying to get a regular mortgage is having too much debt.  Remember, that if your debt to income ratio is higher than 43%, you don't qualify for traditional bank loans.

But there are measure you can take to make sure this isn't a problem for you.

• Option 1:  Pay Down Your Debt.  Take time to pay down your debt as quickly as possible.  This will take time but could be worth it.
• Option 2:  Look into Debt Consolidation.  If you can consolidate your debt, especially at a lower interest rate and a decreased monthly bill, this may be the trick that would help you qualify for that loan.
• Option 3:  Negotiate.  Now, this may not be possible for all of us but if you can, dust off your negotiations skills and get to work.  Talk to your creditors and see if they will work with you to decrease your interest rate and lower your monthly bill.

Bad credit?

Well, first things first.  You have to start increasing your credit score.  Pay your bills on time, make sure your used credit is well below your actual credit limit, pay down your debt, and make sure all your accounts are in good standing. Also, consider getting a co-signer for your loan who has excellent credit.

In the end, you may just have to be willing to put down a larger down payment and pay higher interest rates.  But if you are a first time home buyer, you may want to look around for programs that are willing to work with you.

Did you have a recent Foreclosure?

If you've had a recent foreclosure, and, apparently, if it is due to a qualified financial hardship (ie. a medical emergency, loss of a job, etc), you could have your waiting period waived!

Of course, you will still need to prove that you are now able to make the payments without any trouble and that you have good credit.

Are you an Expat or a Foreign National?

If you are, you have to do some digging but there are some companies out there willing to work with you. 

One company I recently came across, American Mortgages, offers services to both expats and foreign nationals looking to purchase a property in the US. They offer you the option to base your financing on your tax returns or base it on the rental property's projected rent!  

Conclusion

For those unable to get home loans the traditional way, Non-QM Loans offers you a way to finally become a home owner.  But while it comes with its perks, there are also downsides to going this route.  

Before you make the leap, make sure you fully understand the terms of your loan and determine if this is really the right decision for you and your financial future.