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Traditional mortgage loans work great for those living a traditional lifestyle: working a job with a steady income and looking to buy a home to live in.
But real estate investors — and many others, such as self-employed entrepreneurs and gig workers — may sometimes find it difficult to obtain financing via traditional, qualified mortgages.
Enter: the non-qualified mortgage (non-QM).
What Is a Non-Qualifying Mortgage?
A traditional qualified mortgage (QM) refers to a category of mortgage loans that have features designed to make them less risky. These include stipulations like requiring borrowers to verify their income and demonstrate an ability to repay; limiting upfront points, fees, and annual percentage rate (APR); and restricting loans with terms longer than 30 years.
These rules help reduce the risk to lenders and typical mortgage borrowers, but they create extra restrictions for real estate investors looking to secure financing for investment properties.
Non-QM loans are mortgage loans that do not meet the qualified mortgage standards set by the Consumer Financial Protection Bureau (CFPB). Non-QM loans provide alternative financing options for real estate investors when they may not qualify for a conventional mortgage due to factors like unconventional income sources, a high debt-to-income ratio, or a unique property type.
Specialized lenders willing to take on higher risks associated with unconventional borrower profiles typically offer these loans. Non-QM loans often have flexible underwriting criteria and permit alternative documentation of income and assets. This allows investors to qualify based on factors such as asset strength, property cash flow, or projected rental income rather than traditional income verification methods and the dreaded “ability-to-repay” rule.
For example, some non-QM lenders use debt service coverage ratio to measure the property’s cash flow, rather than verifying the borrower’s income.
Uses of Non-Qualified Mortgage Loans
Non-QM loans can serve real estate investors in several key ways depending on your situation.
Many real estate investors must consider a non-qualified mortgage because some types of properties don’t meet traditional qualified mortgage lending standards. Non-QM loans enable real estate investors to secure financing for a wide variety of investment property types, including fix-and-flip properties, multi-unit properties, vacation rentals, or commercial properties.
The other main use of non-QM loans for real estate investors is to get around the income documentation requirements that conventional loans carry. Because many real estate investors make the bulk of their income through their properties and other investments, they don’t always have a pay stub they can show a banker to prove their income.
Instead, non-QM loans consider alternative income sources, proof of other assets owned, or bank statements to determine a borrower’s capacity to repay. You can also use the income you intend to generate from the property to help you qualify.
And, not for nothing, non-QM loans usually offer more leniency for borrowers with imperfect credit ratings. These lenders usually focus more heavily on the value of the property and the borrower’s equity rather than fixating on your credit score. Some lenders even offer non-QM loans to borrowers with past bankruptcies or foreclosures on their credit report.
Non-QM loans resemble hard money loans, except they tend to have substantially lower interest rates—although still higher than conventional mortgages. Interest rates on non-QM loans vary from lender to lender and depend on the borrower’s down payment and credit score.
Pros & Cons of Non-QM Loans
Real estate investors should carefully weigh the pros and cons of non-QM loans. Your individual financial situation, your investment goals, and even the characteristics of the specific property in question can influence whether non-QM loans align with your needs and risk tolerance. Consult with a mortgage professional or financial advisor to review your specific situation, but in general, non-QM loans carry these pros and cons.
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