With many economists predicting the Federal Reserve to continue to rise rates to combat inflation, that spells unwelcome news for many would-be first-time homebuyers looking to purchase a property.
The Fed has already raised rates three times this year and most expect that we’ll see two more rate hikes before 2022 comes to a close. If true, the housing market will continue to see an increase in denied borrower applications for mortgages. A one percent increase in interest rate from 4 to 5% on a $400,000 loan results in a payment difference of $238.
According to Freddie Mac, the average 30-year fixed mortgage interest rate is currently nearing 7%.
Many buyers looking to acquire their first piece of real estate may have to turn to non-qualified mortgages (non-QM) to find financing. Non-QM loans are loans that do not meet the Consumer Finance Protection Bureau’s definition of a qualified mortgage which must meet the ability-to-repay rule.
While this is true, non-QM loans are not the wild wild west that many experienced before the 2008 housing market crash. Many non-QM lenders are still required to make good-faith efforts to ensure borrowers can repay their mortgages.
Non-QM loans are best for individuals that are self-employed, have recent credit events, own a high net-worth, foreign nationals and investors.
Self-employed borrowers all face a common issue – showing enough income on tax returns to qualify for a mortgage. One of the main reasons to become self-employed is also the largest detriment in trying to get a loan as most business owners write off a lot of expenses on their tax returns to reduce their tax bill.
Most conventional lenders will require self-employed borrowers to show two-years’ worth of tax returns to determine their qualifying income. If a business owner wrote off most of their expenses, their income could come in too low to qualify. However, with a non-QM lender these borrowers can use bank statement income to qualify.
In many cases, a non-QM lender will evaluate 12-months’ worth of bank statement income and apply a 50% expense factor. Most lenders will allow a borrower to obtain a CPA letter to use a lower expense factor to qualify.
This program also applies to 1099 workers who might also have a lot of tax write-offs.
Borrowers with Recent Credit Events
One of the largest benefits of using non-QM lenders to qualify for a mortgage is that many of them will allow a borrower to purchase a home one day removed from a discharged bankruptcy, foreclosure or short-sale.
Conventional loans often require a borrower to wait as long as four to seven years before purchasing a home with this type of credit history.
The industry standard seasoning period from a recent credit event is 36-months with most non-QM lenders, however for a higher rate you can obtain financing just one day removed from said event.
Investors & Foreign Nationals
Investors looking to score their next rental property often turn to non-QM mortgages to obtain properties swiftly.
Most Non-QM lenders offer a Debt Service Coverage Ratio (DSCR) loan that is used for investment real estate purposes. These loans are attractive because they do not require any income verification. The lending decision is based solely on the fact that the monthly rental income can cover the full mortgage payment.
Lenders will still impose down-payment, credit score and reserve requirements to qualify for this program.
Foreign Nationals can also use this program to buy property within the United States.
High Net Worth Borrowers
Borrowers with a high net-worth are also drawn to non-QM mortgages as certain lenders have total asset loans. These loans are best for retirees and those that have many assets but not enough income to qualify.
The lending decision is based on the total assets of the borrower. In most cases, a lender will require the borrower to have a certain amount of assets that exceed the purchase of the home, down payments and covers monthly obligations for certain number of years.
Drawbacks of Non-QM Loans
While these loans can provide a solution for the unique borrowers who may need them, these types of loans do come with a few drawbacks.
These loans are riskier to lenders therefore borrowers can expect to see higher interest rates, origination fees and down payments. Typically, non-QM mortgage rates are 1 to 2 percent higher than conventional loans. However, everyone’s situation will be different once their qualifications are evaluated.