To the casual observer, it probably makes very little difference if a loan is “QM” or “non-QM.”
And unless you’re in the mortgage business you probably have no idea what the designation actually means.
But it is a big deal if you’re in the mortgage business as there are special considerations given to loans that fall into the QM category.
What are no-QM loans and how to do they serve southern California home buyers?
QM stands for “Qualified Mortgage” and is a term that applies to a major segment of the mortgage industry. The features of a QM loan were implemented at the beginning of 2014 by the Consumer Financial Protection Bureau, or CFPB. When a lender follows QM guidelines when approving a mortgage loan the lender is offered certain legal protections. Most loans issued today follow the QM guidelines but they’re really not all that difficult to follow as most of the non-QM loans the CFPB targeted when writing the AM rules are no longer available.
Simply put, a QM loan is one where the lender has determined the borrower has a distinct “ability to repay” the loan along with keeping up with other monthly credit obligations. This is accomplished by keeping a borrower’s total debt to income ratio at or below 43. That means total credit payments, which include not just principal and interest but a monthly amount for property taxes, insurance and homeowners association dues where applicable.
The total housing payment plus other credit accounts such as a car payment and minimum credit card payments are also added to the amount and then divided by gross monthly income. This ability to repay, or ATR, is another acronym assigned by the CFPB and requires compliance in order to receive the QM designation.
For example, if a couple’s gross monthly income is $10,000 the lender would need to make sure the total monthly debt did not exceed 43% of $10,000, or $4,300. This level of monthly debt shows the borrowers have the ability to repay the debt. The lender may still approve a loan with a debt ratio above 43 but the loan would then not meet QM guidelines.
The Rules of Non-QM Home Loans
QM loans have characteristics that provide for a more stable mortgage for the borrowers with a lower likelihood of default. Along with keeping total debt ratios in line, upfront fees charged by lenders cannot exceed 3.0% of the loan for all mortgages of $100,000 or more.
In addition, so-called “interest only” loans can cause a loan to lose its QM status. An interest only loan is a mortgage where borrowers have the option of paying a fully amortized amount where a portion of the payment goes toward interest as well as the loan balance or an interest only payment where only a minimum amount of interest is paid while not paying anything toward the outstanding principal balance.
Negative amortization is also not allowed on a QM loans. Mortgage loans naturally amortize, or pay down, over a predetermined period. Negative amortization loans provide the borrowers with the option of paying less than the minimum interest payment required then the loan balance could actually increase instead of being paid down. “Neg-am” loans were popular up until the financial debacle hit the mortgage markets. Borrowers who took neg-am loans and didn’t make a fully amortizing payment and did not make a minimum interest payment soon discovered they owed more than they originally borrowed with many borrowers ending “upside down” with their mortgages.
“Balloon loans” are also not allowed. A mortgage with a balloon feature means the borrowers could make regular monthly payments but a certain point the full amount of the loan would become due. The borrowers would be forced to refinance the loan, sell the property or otherwise pay off the balloon note. And finally, a QM loan’s term cannot exceed 30 years. For a time, many lenders offered a 40 year amortization period to help people qualify by lowering the monthly payment.
If a mortgage met these basic requirements it received QM status. If not, it’s a non-QM loan. However, that doesn’t mean a non-QM loan is a bad choice. It’s not. There are times when a non-QM loan is a much better choice than a QM mortgage and it helps to work with a lender experienced in both.
Non-QM Characteristics
When a mortgage loan does not meet QM standards it’s typically because the borrowers have different circumstances for a particular mortgage transaction. Non-QM mortgages in Southern California are not considered high risk nor are they for those with less than perfect credit. Non-QM loans today are not subprime mortgages.
One of the more common non-QM loans is a mortgage with an interest only option. Interest only loans can be an ideal choice when the borrower has irregular income or gets paid less frequently and in bigger chunks than say someone who gets paid the same amount on the 1st and 15th of each month. Many of these borrowers are business owners or get the bulk of their income from commissions or bonuses. An interest only borrower could elect to pay interest only at their leisure and then make a larger payment at some point in the future. For example, a sales representative who gets a quarterly bonus might benefit from an interest only loan paying a smaller payment for two months then a larger one when the quarterly bonus is paid.
Loans that do not comply with standard income documentation can also be non-QM. The self-employed borrower is required to provide two years’ worth of federal income tax returns showing consistent year-over-year income. If a borrower cannot provide such documentation or the income isn’t consistent, the borrower can take a mortgage that requires less documentation of income such as just one year of tax returns or a so-called “stated” income loan where the lender uses the income stated on the loan application without documenting it.
Our non-QM loans do require income documentation however.
Higher income earners can take advantage of a non-QM loan and especially so here in Southern California where real estate values are much higher than in other parts of the country. If debt ratios exceed 43% of borrower income, the loan would be considered non-QM. Yet higher income individuals can have higher debt ratios because there is so much more residual income.
Someone with a 50% total debt ratio making $20,000 per month still has $10,000 per month in gross income available while someone making $3,000 per month would only have $1,500 in gross monthly income. For high income earners, a non-QM loan could be an excellent choice.
Knowing Why A Non-Qm Loan Is A Great Option
A non-QM loan can also be an excellent option of current income is lower than what will be expected in the near future. For example, a couple buys a house and a spouse have not yet started a new job but will start in two months. Debt ratios could be temporarily high but the lender understands the high ratios will soon be lowered once the spouse goes to work.
All mortgage loans in today’s marketplace are either QM or non-QM. Conventional loans such as those underwritten to Fannie Mae and Freddie Mac guidelines can be either, but most are in fact QM. VA, FHA and USDA loans may also fit in the QM category but sometimes, as with conventional mortgages, a particular loan falls out of the QM category because a debt ratio was 45% yet still received a standard approval. Portfolio loans are often in the non-QM category because the lender approves a loan using its own lending standards and does not intend to sell the loan but keep it in its own “portfolio.”
We at Home Point Financial offer the complete array of QM and non-QM options for borrowers in Southern California.
When first applying for a mortgage it’s really not that important to know whether or not a loan has QM status or not but instead making sure you get a mortgage that fits your personal situation.
