Non-QM Loan: Overview, Pros and Cons, Example

Key Points

Non-qualified mortgages cater to those with nontraditional incomes or credit issues.
These mortgages may offer lower initial payments but carry higher long-term costs.
Non-QM loans don't meet CFPB standards, whereas nonconforming loans don't follow Fannie Mae and Freddie Mac purchasing guidelines.

Most people are familiar with typical mortgages, like FHA, VA, and conventional loans, but you may not realize that there's a whole other group of mortgages called non-qualified mortgages. A non-qualified mortgage includes features not found in standard mortgages or allows borrowers who are excluded from traditional mortgage products.

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Housekeys and a calculator sitting atop a mortgage contract. — Image source: Getty Images.

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About the Author

Kristi Waterworth has been a contributing real estate and financial expert at The Motley Fool, covering real estate, investing, and personal finance topics, since 2020. Kristi has been interviewed by various TV media outlets and podcasts for her real estate investing expertise – from residential real estate to digital real estate and everything in between. Kristi’s journalist career spans over 25 years, and she has written about real estate investing, homeownership, and home construction specifically for the last decade. She was also previously a licensed Realtor and general building contractor before the Great Recession and housing market collapse. She holds a bachelor’s degree in American history from Columbia College in Missouri.

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Pros and cons of a non-qualified mortgage

People often have knee-jerk reactions about non-qualified mortgages, assuming they're always scams or underwritten by bad actors. But the truth is, they can be useful for specific purposes.

Pros

Alternative income verification methods allowed. People with self-employment income, gig economy income, or who live off investment income may have a better chance of being approved for a non-QM loan.

Credit qualification can be more flexible. People have credit problems for all kinds of reasons, including messy divorces, unexpected and serious medical conditions, or unplanned losses of income. Most non-QM loans are manually underwritten, allowing each company to decide if these things are signs of risk, or simple one-time runs of bad luck.

Lower initial payment. Suppose you live in a housing market with extremely high prices compared to average incomes. If you expect that your income will grow -- say, for example, you've just graduated from college -- the lower initial payment that's possible with certain types of non-QM loans may make buying a home easier. Options like interest-only loans can get you started on home ownership -- just don't forget that you almost always have to refinance these loans at some point.

Cons

Increased risk of default. It's well-known that non-qualified mortgages are more likely to go into foreclosure because of the way they're put together. That doesn't mean you're guaranteed to run into trouble, but the risk is higher.

Higher costs over the loan's lifetime. Because non-QM loans often carry slightly higher interest rates, borrowers end up paying more each month for their mortgage. They may also pay more at closing for the note, since non-QM mortgages aren't regulated in the same way as qualifying mortgages are.

Unusual features. It can be easy to encounter problems with non-qualified mortgages because of unusual features that come with them, like balloon payments, interest-only payments, or pre-payment penalties. If a borrower doesn't understand the consequences of these loan features, they can create serious long-term issues.

Non-QM Loan: Overview, Pros and Cons, Example

Key Points

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What is a non-qualified mortgage?

Pros and cons of a non-qualified mortgage

Pros

Cons

Non-qualified mortgages vs. nonconforming mortgages

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