A non-qualified mortgage (non-QM) is a home loan designed to help homebuyers who cannot meet the strict criteria for a qualifying mortgage. For example, if you are self-employed or do not have all the necessary documents to qualify for a traditional mortgage, you may need to consider non-qualifying mortgages.
The best way to understand an ineligible mortgage is to look at the criteria for traditional eligible mortgages. To qualify for a traditional mortgage, you must meet these requirements:
- Income: You must have verifiable income, including pay stubs, W-2 forms, and tax returns.
- Debt: Your debt to income ratio (DTI) must be 43% or less. This is the amount of your monthly income that goes towards your existing debts.
- Fee limits: Points and fees on your loan cannot exceed 3% of the loan amount.
- No Risk Loan Features: Risky features include interest-only loans (where you only pay interest without reducing principal), negative amortization (where your principal can grow, even while you make payments) or lump sum payments (where a payment larger can be added at the end of the loan).
- Term of the loan: The term of the loan must be 30 years or less.
If you can’t check all the boxes above, you’ll need to look into ineligible mortgages.
Essentially, mortgage lenders need to know that you have the ability to repay your loan. The above regulations also protect buyers against subprime lending. These minimum standards for qualified mortgages are part of the Consumer Protection Act of 2010 and the Dodd-Frank Wall Street Reform Act.
Why do these regulations exist? In the years preceding the Great Recession, lenders seemed willing to approve mortgages for anyone with a pulse, including those with poor credit and low down payments. Some mortgages did not verify income at all. Unethical lenders are reportedly pressuring homebuyers for unaffordable mortgages. This willy-nilly approach was one of the reasons the recession hit with such ferocity. Millions of people who had home loans could not afford the payments.
Today, as long as lenders follow these strict lending guidelines, they are protected from liability. Borrowers can’t go back (as many did during the Great Recession) and pretend a lender knew they couldn’t make the monthly payments.
Non-qualified mortgages are not backed by government agencies like the FHA, VirginiaFannie Mae and Freddie Mac.