What is a Non-QM Mortgage?
To explain what non-QM lending is, we should start with an explanation of what QM or a “Qualified Mortgage” means. The delineation between a qualified and a non-QM mortgage came about in response to the financial crisis of 2008. Specific provisions around mortgage lending were enacted around 2010 with the roll-out of the Dodd-Frank Wall Street Reform and Consumer Protection Act which was put in place to help prevent another financial crisis. As part of this legislation, a qualified mortgage was defined as a home loan that meets certain criteria which make the loan less risky for lenders, investors, or other entities who purchase the loans, and for consumers who have to pay back the loans.
To be eligible for a QM loan, borrowers must meet specific requirements that show that they are able to pay back the loan - referred to by the industry as “ATR” or “ability to repay”. Some of the qualification factors include income, assets such as savings or investment accounts, and monthly debt obligations such as car and credit card payments. In order for borrowers to show ATR, there are maximum debt-to-income ratios that must be met to ensure that borrowers can afford the mortgage payments. QM loans also have restrictions on the number of points and total fees that lenders can charge and also prohibits lenders from structuring the loans with non-traditional characteristics such as a balloon payment, negative amortization, and short-term fixed rates that significantly increase once the fixed period expires.
A non-QM or non-qualified mortgage, on the other hand, is a loan that does not need to meet the strict requirements mentioned above. Non-QM loans are not sold to Fannie Mae and Freddie Mac, the two government-sponsored agencies that purchase most of the qualified mortgages originated in the U.S. Fannie and Freddie’s primary purpose is to provide liquidity for the banks, credit unions, and mortgage lenders who provide home financing, ensuring that mortgage originators are able to free up capital to fund more loans. Often referred to as “agency loans”, Fannie and Freddie only purchase loans that fit the QM box. Because non-QM lenders are not beholden to Fannie and Freddie and the strict loan guidelines for QM loans, non-QM lenders are able to offer more flexibility in their loan underwriting decisions. This is good for borrowers who don’t fit the QM box.
The Important Role of Non-QM Mortgage Lenders
Non-QM loans are an important part of the housing market ecosystem and without their existence, hundreds of thousands of families would be unable to experience the joys of homeownership. Borrowers who need a non-QM loan are not necessarily higher-risk borrowers; they simply don’t check all the boxes of a QM loan.
Non-QM loans are ideal for borrowers who have non-traditional sources of income or assets, have inconsistent income, or have a less than ideal credit history including:
- Self-employed borrowers
- Gig-economy or contract workers
- Business owners
- Real estate investors
- Borrowers with a thin credit file or past credit challenges
The Continued Rise of Non-QM Lending
Though non-QM lending came to a screeching halt due to the COVID-19 pandemic, many reports predict that non-QM loan origination volume in 2021 will return to pre-pandemic levels. A report by S&P Global estimates that non-QM loan volume in 2021 will reach an estimated $25B, and some reports predict origination volume as high as $50B. This increase is bolstered in part by decreasing refinances, an increase in gig and contract workers, and the adoption of technology and automation by non-QM lenders which is streamlining and simplifying the non-QM process for borrowers and lenders.
While non-QM lending may be behind traditional lenders when it comes to a fully automated, 100% digital application process, much progress has been made to automate certain steps in the process. For example, some non-QM lenders are developing automated underwriting engines similar to what exists in agency underwriting to issue faster initial approval decisions, and many non-QM lenders are implementing artificial intelligence to quickly analyze qualification documents such as bank statements and tax returns.
Non-QM mortgages are a great option for credit-worthy borrowers unable to obtain financing from traditional sources. As long as non-QM lenders are able to leverage technology and automation to create a great experience for borrowers, non-QM lending will continue its rise toward achieving mainstream status.
MoneyThumb’s PDF Insights software helps non-QM and small business lenders process and analyze an unlimited number of bank statements in seconds, reconcile balances, and using a proprietary AI-driven, patent-pending feature, Thumbprint™, detect fraud in seconds, helping underwriters make decisions faster and more confidently. Contact us for a live demo.