The qualified mortgage (QM)
In 2014, in response to the mortgage crisis of 2008, the Consumer Financial Protection Bureau (CFPB) created a new home loan product: the qualified mortgage (QM). This new type of loan classification falls under the Dodd-Frank Wall Street Reform and Consumer Protection Act.
It requires lenders to make a good-faith effort to ensure loan applicants have the ability to pay back the loan. As such, there are many rules for lenders, and those rules fall under the borrower's ability-to-repay (ATR) rule.
The ability-to-repay (ATR) rule
The ATR rule mandates that QM loans can't have risky features, such as negative amortization, a balloon payment, an interest-only term, excessive points and fees, and a loan term that extends beyond 30 years.
Other rules to be a QM include a debt-to-income (DTI) ratio no higher than 43%, and the loan must meet the standards that make the loan eligible for purchase or guarantee through the FHA, VA, USDA, or a government-sponsored enterprise (GSE) such as Fannie Mae and Freddie Mac. These loans require applicants to provide pay stubs, tax returns, and bank statements.
If the loan doesn't meet all the qualifications of a qualified mortgage (QM), it's called a non-qualified mortgage (non-QM).
The non-qualified mortgage (non-QM)
A non-QM loan still must meet ATR standards, but it doesn't need to meet the other rules. For example, a non-QM loan could be an interest-only loan or granted by a mortgage lender to applicants with a DTI higher than 43%. It can be granted to people who don't have a steady, verifiable income stream or proper income documentation, such as the self-employed, real estate investors, and people who work gig jobs or are independent contractors.
Business owners, for example, typically use business expenses to offset their tax bill, but that practice makes their income less attractive to lenders. Non-QM lenders, in these cases, look at bank statements instead.
To offset some of the risk of the non-QM loan, some lenders will charge a higher interest rate for this loan and could require a high credit score and low loan-to-value (LTV) ratio (achieved by a larger down payment).
Non-qualified mortgage vs. subprime mortgage
Although a non-QM loan shares some similarities with a subprime loan, they are different products. Meeting ATR requirements and the intent of the lender are what make them different.
With subprime loans, the intent of the lender must meet a loan quota. In the days leading up to the 2008 mortgage crisis, lenders were pushing subprime mortgages to people who had no verified method of paying back the loans. The result was an unprecedented number of defaults.
With a non-QM loan, the intent of the lender is to grant a mortgage loan to people who don't qualify for a QM loan but who still have the ability to pay back the loan. CoreLogic reports that delinquency rates for non-QM loans are no higher than they are for QMs. In fact, in 2018, the delinquency rate for non-QMs was slightly lower.
The real estate investor takeaway
Real estate investors, such as house flippers, who are in the market for a mortgage loan to buy an investment property and don't qualify for a standard mortgage have options, such as hard-money lenders and borrowing from friends and family.
Another option is the non-QM loan, a product worth looking into. As long as you can show a loan officer you have the ability to repay the loan, you should be good to go.