Qualified Vs. Nonqualified Mortgages: What You Need To Know

Qualified mortgages were created in 2014 to make it more likely that a borrower could afford and pay back a home 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 nonqualified mortgages 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 Is A Qualified Mortgage?

A qualified mortgage loan (QM loan) meets all the consumer protection requirements of the Dodd-Frank Act. Borrowers must have a reasonable debt-to-income ratio (DTI), and mortgage lenders can’t offer mortgage products with artificially low introductory monthly payments that sharply increase when the teaser period ends.

What Are The QM Rules?

To understand what a qualified mortgage is, it’s helpful to look at the requirements that lenders must meet to offer you a qualified mortgage. Qualified mortgages can’t have:

• Risky loan features: Lenders can’t offer artificially low monthly loan repayments in the early years of the loan term or provide loans with risky features. These may include interest-only loans, balloon loans or negative amortization
• A high percentage of a borrower’s income going toward their debt: There are limits to how much of a borrower’s income can go toward their debt. The amount of your income that goes toward your debt is known as your DTI ratio, and it generally can’t exceed 43%.
• Excess upfront costs and fees: The limit on costs and fees will vary by the size of the loan, but if costs and fees are over the threshold, the loan can’t be considered a qualified mortgage.
• Loan terms longer than 30 years: Lenders must offer loans with repayment terms of no more than 30 years. Most often, borrowers will be able to choose a 15-year or 30-year mortgage.

A qualified mortgage also indicates your lender has followed the “ability-to-repay” rules, meaning the 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 can repay the loan they’re offering you.

What Is 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 be able to offer you a qualified mortgage. Or, if you have erratic income and don’t meet the income verification requirements set forth in Dodd-Frank, you may not be eligible for 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 you don’t meet the specific criteria for a qualified mortgage.

Interest rates on loans will vary from lender to lender, but you may find that a nonqualified mortgage will have a higher interest rate. This is because lenders often find these loans riskier since the borrowers who apply for them typically have more debt and less stable incomes.

Who Can Benefit From Nonqualified Mortgages?

Most borrowers end up with a qualified mortgage. However, a nonqualified mortgage is an easier option in some circumstances. This may be the case for the following types of borrowers:

• The self-employed
• Business owners
• Those with high levels of debt
• Those with low credit scores
• Real estate investors
• Freelance or gig-economy workers with varying incomes

Nonqualified mortgages allow these borrowers to get into a home more easily than a qualified mortgage.

QM Vs. NonQM Loan FAQs

While there are differences in how you qualify for a qualified mortgage and a nonqualified mortgage, differences also exist in the actual loan. Here are a few frequently asked questions so you can better understand your options.

What legal protections do qualified mortgage 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 lenderslegal protection from lawsuits that claim they didn’t verify a borrower’s ability to repay. However, if a borrower doesn’t believe alender ensured 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 nonqualified loans?

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. Lenders must verify and document anything that supports the borrower’s ability to repay. This includes income sources. Lenders may also want to verify assets or anything else that gives them assurance the borrower can repay the loan.

NonQM loans aren’t insured, guaranteed or backed by the FHA, VA, Fannie Mae or Freddie Mac.

What is the benefit of applying for a qualified mortgage?

Qualified mortgages are the most common type of loans. Applying for a qualified mortgage means you’ll be able to find a loan with a lower interest rate and a monthly payment you can afford more easily.

What is the benefit of applying for a nonqualified mortgage?

Nonqualified mortgages allow borrowers that otherwise wouldn’t qualify for a mortgage to be eligible for a home loan. If you have a low credit score, a high debt-to-income ratio or income that varies enough for a traditional mortgage not to be an option, a nonqualified loan may be the right fit for you.

How can I tell which type of loan is right for me?

If you can’t qualify for a qualified mortgage, ask your lender to explain why. If they tell you it’s due to unstable income, higher-than-allowed DTI, a low credit score or a similar issue, a nonqualified mortgage may be a good fit. However, if you have stable income, a DTI of 43% or less, and good credit, a qualified mortgage is a better choice.

The Bottom Line

Taking out a nonQM loan can be a great option for borrowers who may not be able to secure a qualified mortgage loan due to unreliable income, high DTI or a low credit score. Lenders still have standards for nonQM borrowers and need to assess the borrower’s ability to repay, but the qualification requirements are more relaxed.

However, an alternative to a nonqualified mortgage will be a better fit for some. If you’re ready to buy a home but aren’t sure which type of mortgage is right for you, apply online.