QM vs Non-QM Mortgages: Everything You Should Know

In 2013, the Ability-to-Repay (ATR) rule was formally introduced as part of the Wall Street Reform and Consumer Protection Act. It established the rules and guidelines that mortgage lenders must follow to ensure borrowers can repay their loans. And the implementation of these rules has given birth to what’s now popularly called Qualified Mortgages or QM loans. 

At almost the same time, with only a couple of months behind, another type of mortgage was created as a direct result of the strict criteria set by the QM requirements. These alternative types of loans are now called Non-Qualified mortgages or non-QM loans. Since their inception, they have continuously evolved to meet the needs of borrowers, unlike their opposites, who are still stuck in 2014. One of the best examples of non-QM loans are DSCR loans, which allow borrowers to qualify for a mortgage through property’s rental income (i.e. DSCR score)  

Today, non-QM loans have a yearly volume of around 30 billion dollars. 

In this article, we’ll discuss what a QM loan is and what a non-QM loan is. We’ll give you all the most important information about them and explain what is the difference between QM and non-QM mortgages. We’ll talk about the distinct requirements of both mortgage types, how they are regulated, as well as all other main things that separate them from each other. 

QM vs Non-QM: What Is a Qualified Mortgage?

Qualified mortgage loans, or QM loans, are loans that meet the requirements and rules set by the Consumer Financial Protection Bureau (CFPB). The main reason for these rules, which we’ll discuss below, is to ensure that borrowers can actually repay their loans. To better explain this, let’s take a look at some of the basic prerequisites for qualified mortgage loans:

Main QM Loan Requirements

Most qualified mortgage lenders will have certain rules and obligations that you must fulfill before you can get a loan. The main requirements include:

• Strict Debt-To-Income ratio (DTI) — QM-type loans have tough restrictions on how much of your income can go towards repaying your debt (i.e., your DTI). The highest DTI for qualified mortgage loans can be set between 43% and 57%, based on the exact type of loan. The problem with this is that it negatively affects people who don’t have a steady monthly income (e.g., real estate investors, freelancers, self-employed people, etc.) or don’t have an income but have decent cash flow (e.g., through rent, savings, etc.) 
• Limited loan terms — Most qualified mortgages will have a loan term limit of up to 30 years. And in some cases, you’ll only be able to choose between a 15 or 30-year loan repayment term.
• Ability to repay — Before giving you a qualified mortgage, lenders of this type of loan are legally obligated to make sure you can actually repay it. This means that you’ll have to give them full access to all of your financial and employment information before they can make their final decision. 
• High credit score — Qualified mortgage lenders, in no small part, rely on the borrowers’ credit score to approve or deny their loan application. Ideally, you’d want to have a credit score of at least 620 to get any reasonable chance for loan approval.

QM vs Non-QM: What Is a Non-Qualified Mortgage?

Non-QM loans are mortgages that don’t adhere to the overly strict rules imposed by the  Consumer Financial Protection Bureau (CFPB). The main goal behind these types of loans is to allow people who don’t have a steady monthly income (e.g., real estate investors, businesses, freelancers, seasonal workers, etc) to get a mortgage.

Instead of focusing only on your W-2s or pay stubs, lenders will consider various other financial information to ensure your ability to repay the loan. Depending on the exact type of loan, non-QM loan lenders will look at your cash flow, assets, savings, rental income, and more to perform the underwriting. 

In essence, non-QM mortgages offer borrowers a broader spectrum of opportunities to demonstrate their capacity to repay the loan compared to the more rigid QM loans. 

Non-QM Loan Requirements

The exact requirements will depend on the type of non-QM loan you go for. But speaking in general terms, the main Non-QM loan requirements that you should expect to encounter will  include:

• Different types of financial documents (e.g., proof of assets, bank statements, etc.)
• A downpayment between 15% and 25%
• In some cases, lenders will take a look at your credit history 
• Interest rates are in the range of 7%-12% (depending on the type of loan). At the time of writing (April 2024), interest rates are higher than usual because central banks keep raising them to combat inflation.
• Some types of non-QM loans will have specific property requirements. For example, DSCR non-QM loans can only be used to purchase rental property (i.e., they can not be used to finance your primary, secondary, or vacation house). These types of loans are based on a metric called the DSCR score, which is used to calculate the property’s ability to generate income. By calculating the DSCR score, lenders can determine whether or not to approve a specific loan application.    

Who Are Non-QM Loans For?

Non-QM loans are for people who don’t meet the outdated requirements of QM loans and whose streams of income are not neatly spread on a month-to-month basis (which is one of the main requirements for QM loans).  These groups of people include:

• Real estate investors
• Foreign nationals
• Freelancers
• Small or medium-sized business owners
• Self-employed people
• People who already have a high debt
• People with a credit score below 620
• Seasonal workers 

Main Types of Non-QM Loans

There are a lot of different types of non-QM loans, with the most popular of them being:

• Foreign national mortgage loans
• DSCR loans
• ITIN mortgage loans 
• Jumbo loans
• Investor loans

What Is the Difference Between QM and Non-QM Loans?

Here are some of the major differences between QM and non-QM loans.

Risk Assessment 

The first big difference between QM and non-QM loans is how lenders assess risk when dealing with borrowers.

The QM loans follow a risk assessment that is outdated in the modern world. The ideal QM loan borrower is someone with a secure job at a reputable company and a steady monthly income. And that, in and of itself, excludes many people. People who still have the ability to repay the loan but don’t neatly fit into the overly narrow requirements for QM loans.

QM loans excluded a considerable part of the population who are self-employed, own small to medium-sized businesses, or don’t have a steady monthly income (e.g., seasonal workers). This is precisely why non-QM loans were invented and became extremely popular and why the yearly volume of these loans reached 30 billion dollars in 2023. Simply put, non-QM loans allow borrowers to prove their ability to repay the loan in many different ways. The non-QM lenders are still doing the risk assessment; it’s just that they consider more factors than lenders of QM loans.

For example, let’s say you’re a landlord and live off of rental income but are not technically employed and don’t have a W-2. In that case, you’ll be hard-pressed to get any type of QM loan. But, with non-QM loans, or more specifically, with a particular kind of non-QM loan called  Rental Income Mortgage Loans, you’ll be able to use monthly rent (instead of a W-2) to qualify for a mortgage. 

Property Types 

Another big difference between QM and non-QM loans is the types of properties you can finance with them. While QM loans are mainly used for primary residences, non-QM loans can also be used for vacation homes and investment properties. 

Eligible Borrowers

QM loans are only available to US citizens and permanent residents (i.e., Green Card holders). On the other hand, non-QM loans are available to all foreign nationals, temporary residents who moved to the US for work or to study (e.g., students on an F-1 Visa), as well as US citizens and Green Card holders. 

QM vs. Non-QM Loans Main Differences: Table