Qualified mortgages, a new category of mortgage, are now available. If you never heard of them, they were established in 2014 to increase the likelihood that borrowers would be able repay their loan. Lenders must assess the borrower’s ability to repay, and borrowers must meet strict criteria.

Borrowers who don’t meet these criteria won’t get approved for qualified mortgages. These situations might lead to a nonqualified mortgage being offered. These loans can be a poor choice for some borrowers, but they may still be the best option.

Here are some facts about non-qualified and qualified mortgages to help you make informed decisions about each option.

What is a Qualified Mortgage?

Qualified mortgage loans (QM loans) meet all consumer protection requirements under the Dodd-Frank Act. Lenders can’t offer mortgage products that have artificially low monthly payments or increase sharply after the introductory period ends. Borrowers must be in a reasonable debt-to income ratio (DTI).

What are the QM Rules?

It’s important to understand what qualifies as a mortgage. To do so, you need to know the requirements that lenders must meet in order to lend you a qualified loan. These are the requirements for qualified mortgages:

  • Some loans have risky features or offer low monthly repayments, such as interest only, balloon, or negatively amortization loans. These are sometimes called subprime mortgages.
  • A high percentage of borrowers’ income goes towards their debt. There are limitations on how much income a borrower can use to pay off their debt. This is known as the DTI ratio and it cannot exceed 43%.
  • Additional fees and upfront costs . The loan amount will determine the limit of fees and costs. However, if the threshold is exceeded, the loan cannot be considered qualified.
  • Loan terms which are more than 30 years.

Qualified mortgages also mean that the lender has followed the ability to repay rules. Generally, a qualified mortgage means that the lender will inquire about your income, assets and credit history to determine if you are able to repay the loan.

What is a Nonqualified Mortgage?

Nonqualified mortgages (nonQM loans) don’t meet the requirements of the Dodd-Frank Act. These types of mortgages may be available to applicants whose incomes are not consistent from month-to-month or who have unique circumstances.

A lender might not offer you a qualified loan if your DTI is higher than 43%. You may also not be eligible for a qualified mortgage if your income is irregular and you don’t meet the income verification requirements required by most lenders.

An alternative is for a lender to offer you a nonqualified loan. A lender may offer you a nonqualified mortgage. However, they will still need to verify your ability to repay the loan. This simply means you don’t meet all the requirements for a qualified mortgage.

CoreLogic data shows that the main reasons nonqualified mortgage borrowers look for are:

  • Limited documentation
  • DTI greater than 43%
  • Interest-only loans

Lenders will vary in their interest rates, but you might find that a nonqualified loan will have a higher rate.

NonQM Loan FAQs

There are many differences between qualified and nonqualified mortgages. But there are also differences in the loan. These are just a few of the differences between the loans.

What Legal Protections Does QM Loans Offer You?

Dodd-Frank provided protection for QM mortgage lenders in the event of legal challenges during foreclosure proceedings. Lenders can prove that they have made sure you are able to repay your QM mortgage. This protects them from lawsuits that might claim they didn’t verify the ability of a borrower to repay.

If a borrower does not feel the lender was responsible for their ability to repay the loan, they may still sue the lender in court.

Furthermore, QMs cannot be guaranteed, insured or backed FHA, VA Fannie Mae, Freddie Mac. This makes them safer for investors who purchase mortgage-backed investments.

How do Lenders Verify Income for NonQM Loans

NonQM loans may not meet the requirements for QM loans but they aren’t necessarily poor-quality loans. QM borrowers had an overall credit score of 754. NonQM loans had a 79% loan-to-value ratio, while QM loans had a 80%.

However, nonQM borrowers have on average higher DTI ratios that QM borrowers.

Lenders can offer mortgages to nonQM borrowers with flexibility. However, lenders must still verify the information. They must verify and document everything that can be used to support the borrower’s ability repay.

This includes income sources. They might also need to verify assets and other information that can give them confidence the borrower will be able repay the loan.

NonQM loans cannot be insured, guaranteed, or backed up by FHA, VA or Fannie Mae.