Qualified mortgages are a new mortgage classification. Starting in 2014, they were created to make it more likely that a borrower would be able to pay back the loan. Lenders need to assess the borrower’s ability to repay and borrowers need to meet a strict set of criteria.
If borrowers don’t meet those criteria, they won’t be approved for a qualified mortgage. In these situations, you might be offered a nonqualified mortgage. While these loans sometimes have a bad reputation, they might be the right choice for some borrowers. To help you make informed choices about both options, here’s what you need to know about qualified and nonqualified mortgages.
What’s A Qualified Mortgage?
A qualified mortgage loan (QM loan) meets all the consumer protection requirements of the Dodd-Frank Act. Borrowers must have reasonable debt-to-income ratios (DTI), and lenders can’t offer mortgage products with artificially low introductory monthly payments that sharply increase when the introductory period ends.
What Are The QM Rules?
To understand what a qualified mortgage is, it’s helpful to look at the rules lenders need to meet to loan you a qualified mortgage. Qualified mortgages can’t have the following:
- Risky loan features, or those that offer artificially low monthly loan repayments in the early years of the loan term, including interest-only, balloon or negative amortization loans, sometimes referred to as subprime mortgages.
- High percentages of borrower’s income going toward their debt. There are limits as to how much of a borrower’s income can go toward their debt. This is also known as their DTI ratio, and it can’t be more than 43%.
- Excess upfront costs and fees. The limit on costs and fees will vary by the size of the loan, but if they’re over the threshold, the loan can’t be considered a qualified mortgage.
- Loan terms that are longer than 30 years.
A qualified mortgage also means that your lender has followed the ability-to-repay rules. That means that a lender will ask about and document your income, assets, credit history, employment and monthly expenses to make a good faith effort to figure out if you’ll be able to repay the loan they are offering you.
What’s A Nonqualified Mortgage?
A nonqualified mortgage (nonQM loan) doesn’t conform to the consumer protection provisions of the Dodd-Frank Act. Applicants whose incomes vary from month to month or those with other unique circumstances may qualify for these types of mortgages.
For example, if you have a DTI of more than 43%, a lender may not offer you a qualified mortgage. Or, if you have erratic income and don’t meet the income verification requirements set out in Dodd-Frank and required of most lenders, you may not be offered a qualified mortgage.
A lender may instead decide to offer you a nonqualified mortgage. If a lender offers you a nonqualified mortgage, it doesn’t mean they aren’t required to do any verification or assessment of your ability to repay the loan. It just means that you don’t meet the specific criteria needed for a qualified mortgage.
According to data from CoreLogic, the three main reasons borrowers seek out a nonqualified mortgage are:
- Limited documentation
- DTI of greater than 43%
- Interest-only loans
Interest rates on loans will vary from lender to lender, but you may find that a nonqualified mortgage will have a higher interest rate.
QM vs NonQM Loan FAQs
While there are differences in how you qualify for a qualified mortgage and a nonqualified mortgage, there are also differences in the loan itself. Here are some of the ways the loans differ.
What Legal Protections Do QM Loans Offer?
Dodd-Frank offered lenders issuing QM mortgages protection from legal challenges in foreclosure proceedings and other litigation. With a QM mortgage, lenders have shown that they made sure you had the ability to repay your loan. This gives them legal protection from lawsuits that claim they didn’t verify a borrower’s ability to repay. However, if a borrower doesn’t feel that the lender made sure they had the ability to repay, they can still challenge the lender in court.
Additionally, only QMs can be insured, guaranteed or backed by FHA, VA, Fannie Mae or Freddie Mac, so they’re safer for investors who buy mortgage-backed investments.
How Do Lenders Verify Income For NonQM Loans?
Though nonQM loans don’t meet the standards required for QM loans, they aren’t necessarily low-quality loans. CoreLogic data found that in 2018, nonQM borrowers had an average credit score of 760. QM borrowers had an average credit score of 754. The average loan-to-value ratio for nonQMs was 79%, compared to 80% for QM loans.
But, nonQM borrowers do have, on average, higher DTI ratios than QM borrowers.
NonQM loans offer flexibility for lenders to offer mortgages to people who don’t fit the criteria of QM loans, but lenders still need to do the work of verifying the information provided. They need to verify and document anything that supports the borrower’s ability to repay. That includes income sources. They may also want to verify assets or anything else that gives them assurance the borrow will be able to repay the loan.
NonQM loans are not insured, guaranteed or backed by FHA, VA, Fannie Mae or Freddie Mac.
Summary: Should You Consider NonQM Loans?
Taking out a nonQM loan doesn’t necessarily spell doom. For some borrowers with unreliable income streams or a high DTI, a nonQM loan can help them get the money they need. Lenders have still set standards for nonQM borrowers and need to assess the borrower’s ability to repay.
If you’re interested in learning more about mortgage options, head to our Learning Center.