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Non-QM Loans Explained

Non-QM (non-qualified mortgage) loans are mortgage products that do not meet the CFPB's Qualified Mortgage criteria but still comply with the Ability-to-Repay rule. They use alternative income documentation methods such as bank statements, asset depletion, or property cash flow (DSCR) to serve borrowers whose legitimate financial profiles do not fit the standardized QM framework, including self-employed individuals, real estate investors, and foreign nationals.

Key Takeaways

  • Non-QM loans are not illegal or inherently risky; they simply do not meet the specific documentation and feature requirements of the CFPB's Qualified Mortgage definition.
  • Common non-QM program types include bank statement loans, DSCR loans, asset depletion loans, foreign national loans, and interest-only products.
  • Non-QM loans still require lenders to comply with the Ability-to-Repay (ATR) rule, which mandates a reasonable, good-faith assessment of the borrower's repayment capacity.
  • Non-QM lending is fundamentally different from pre-2008 subprime lending because it requires verified documentation of income, assets, or cash flow rather than stated or unverified income.
  • Interest rates on non-QM loans are typically 1-3% higher than conforming rates, reflecting higher lender risk and funding costs.
  • Self-employed borrowers, real estate investors, retirees with assets, and borrowers with recent credit events are the primary populations served by non-QM programs.
  • Down payment requirements for non-QM programs generally range from 10% to 30% depending on the program type, credit score, and property type.

How It Works

How Non-QM Underwriting Differs from Agency Underwriting

Agency underwriting (Fannie Mae, Freddie Mac, FHA, VA, USDA) follows published guidelines with standardized documentation requirements. Income is verified through tax returns, W-2s, and pay stubs. The file is evaluated against specific DTI limits, and automated underwriting systems generate findings that guide the approval process. Non-QM underwriting replaces this standardized approach with program-specific criteria defined by private investors.

Each non-QM investor publishes a set of guidelines for the programs they fund. These guidelines specify acceptable documentation types, minimum credit scores, maximum LTV ratios, DTI limits (if applicable — DSCR loans may not have a personal DTI requirement), reserve requirements, and eligible property types. Non-QM underwriters evaluate the borrower’s file against these specific investor guidelines rather than agency standards.

The process typically involves manual underwriting rather than automated findings. A non-QM underwriter reviews the complete file including the alternative income documentation, credit report, appraisal, and any required explanations for credit events or unusual financial circumstances. Turnaround times for non-QM underwriting may be longer than agency loans because of the manual nature of the review and the complexity of the documentation.

How Bank Statement Income Calculation Works

Bank statement programs require the borrower to provide 12 or 24 months of consecutive bank statements (personal or business, depending on the program). The underwriter reviews the statements to identify and total regular deposits. Irregular or non-recurring deposits (such as transfers between the borrower’s own accounts, loan proceeds, or one-time windfalls) are typically excluded from the income calculation.

For personal bank statement programs, the total qualifying deposits are divided by the number of months to produce an average monthly income figure. For business bank statement programs, the lender applies an expense ratio to account for business costs. If the expense ratio is 50%, only half of the business deposits are counted as income. Some lenders allow the borrower to provide a CPA letter specifying the actual expense ratio for the business, which may be higher or lower than the default assumption .

The resulting income figure is then used to calculate DTI and determine the maximum loan amount. Because bank statement income is calculated differently than tax return income, the qualifying amount may be higher or lower than what the borrower’s tax returns would show. For many self-employed borrowers, bank statement income is higher because it reflects actual cash flow before the deductions that reduce taxable income.

How DSCR Qualification Works

DSCR loans shift the underwriting focus from the borrower’s personal income to the investment property’s cash flow. The fundamental question is whether the property generates enough rental income to cover its own debt obligation. The DSCR formula is:

DSCR = Gross Monthly Rental Income / Total Monthly Housing Payment (PITIA)

Where PITIA includes principal, interest, taxes, insurance, and any association dues. A DSCR of 1.25 means the property’s rental income is 125% of its total housing payment, providing a 25% cushion. A DSCR of 1.0 means income exactly covers the payment with no margin.

Rental income for DSCR calculation is typically documented through an existing lease agreement, a market rent appraisal (Form 1007 or equivalent), or actual rental history through property management statements. The lender may apply a vacancy factor or use the lesser of actual rent and market rent depending on their guidelines. Personal income and employment documentation are generally not required for DSCR loans, though the lender will still pull credit and require asset documentation for reserves and closing costs.

Non-QM Loan Funding and Securitization

Non-QM loans are funded through different channels than agency loans. Rather than being sold to Fannie Mae or Freddie Mac, non-QM loans are typically aggregated into private-label mortgage-backed securities (PLS) or held in portfolio by the originating lender or a warehouse lender. The private securitization market provides the capital that allows non-QM lending to scale beyond individual lender balance sheets.

The availability and pricing of non-QM products are directly tied to investor appetite for these securities. When capital markets tighten (as occurred briefly during the early stages of the COVID-19 pandemic), non-QM lending can contract quickly because the secondary market for these loans dries up. Conversely, when investor demand for yield is strong, non-QM programs expand and rates become more competitive. Borrowers should be aware that non-QM product availability can fluctuate more than agency products.

Related topics include va loans explained, jumbo loans explained, fixed-rate vs adjustable-rate mortgages (arm), and to choose the right loan program.

Key Factors

Factors relevant to Non-QM Loans Explained
Factor Description Typical Range
Documentation Type The method used to verify the borrower's ability to repay. Non-QM programs accept alternative documentation that the QM standard does not accommodate. Bank statements (12-24 months), DSCR ratio, asset depletion calculation, CPA income letters, foreign income documentation.
Credit Score Minimum score varies by program type and investor. Generally more flexible than jumbo but higher than pre-2008 subprime. 620-680 for most programs. 580-620 for some credit event programs with compensating factors. 700+ for best pricing.
Down Payment / LTV Required equity varies by program type, credit score, and property type. Higher risk profiles require larger down payments. 10-25% for bank statement loans. 20-30% for DSCR and foreign national. 15-25% for asset depletion .
Interest Rate Premium Non-QM rates are higher than conforming or agency rates, reflecting lender risk, funding costs, and the absence of QM safe harbor. 1-3% above conforming rates. Varies significantly by program type, credit score, and LTV. DSCR and foreign national may carry the highest premiums.
Reserve Requirements Months of housing payment in liquid assets after closing. Non-QM programs typically require reserves as a risk mitigant. 3-12 months depending on program type, loan amount, and number of financed properties .

Examples

Self-Employed Borrower Using Bank Statement Program

Scenario: A small business owner has operated a consulting firm for 6 years. Tax returns show $95,000 in annual income after deductions, but personal bank statements show average monthly deposits of $18,000. The borrower wants to purchase a $650,000 home. On a conventional loan using tax return income, the borrower qualifies for approximately $380,000. On a 12-month bank statement program, the lender calculates income at $18,000/month.
Outcome: Using bank statement income of $18,000/month, the borrower qualifies for a loan amount up to approximately $580,000 (at 43% DTI with existing debts of $1,200/month). With 15% down ($97,500), the loan amount is $552,500, well within the qualifying range. The interest rate is 1.75% higher than a conventional conforming loan, but the borrower gains access to the home they want using documentation that reflects their actual financial capacity.

Real Estate Investor Using DSCR Loan

Scenario: An investor is purchasing a rental property for $400,000. The market rent appraisal indicates $2,800/month in rental income. The loan terms at 75% LTV ($300,000 loan) produce a total PITIA of $2,400/month. The investor already has 8 financed properties and would face conventional financing restrictions.
Outcome: The DSCR is $2,800 / $2,400 = 1.17, which meets the lender's minimum 1.0 DSCR requirement. The investor's personal income and existing property obligations are not part of the qualification because the DSCR program evaluates only the subject property's cash flow. The investor obtains the loan at 25% down with a rate approximately 2% above conforming levels. No personal income documentation is required beyond credit and asset verification.

Retiree Using Asset Depletion Program

Scenario: A recently retired borrower has $3,200,000 in liquid investment accounts but limited fixed income of $2,400/month from Social Security. The borrower wants to purchase a $900,000 home. Traditional income qualification yields a maximum loan amount far below the needed amount.
Outcome: Using an asset depletion program that divides qualifying assets by 360 months, the calculated monthly income is approximately $8,889 ($3,200,000 / 360). Combined with the $2,400 Social Security income, the total qualifying income is $11,289/month, supporting a loan of approximately $680,000 to $720,000 (depending on DTI limit and existing debts). With 25% down ($225,000), the borrower qualifies for the $675,000 loan needed.

Common Mistakes to Avoid

  • Confusing non-QM loans with pre-2008 subprime loans

    Non-QM loans operate under the Dodd-Frank ATR framework, which requires lenders to verify the borrower's ability to repay. Pre-crisis subprime loans had no such requirement. Non-QM loans use alternative documentation that is still verified and analyzed, unlike the stated-income products of the previous era. Treating non-QM as inherently predatory reflects a misunderstanding of the current regulatory framework.

  • Not shopping multiple non-QM lenders for the same program type

    Non-QM guidelines vary significantly between investors and lenders. One bank statement lender may require 24 months of statements with a 50% expense factor, while another accepts 12 months with a CPA letter for the actual expense ratio. Rate pricing, LTV limits, and reserve requirements also differ. Comparing at least three to four non-QM lenders is essential to finding the most favorable terms.

  • Assuming non-QM is the only option without first exploring agency programs

    Some borrowers who believe they need non-QM could actually qualify for conventional, FHA, or other agency programs with proper documentation strategy. A self-employed borrower whose tax returns show sufficient income after a CPA review may not need a bank statement program. Non-QM should be explored after determining that agency options are genuinely unavailable, not as a default for borrowers who find standard documentation inconvenient.

  • Overlooking the total cost difference between non-QM and agency financing

    A 1.5-2% rate premium on a $500,000 loan represents $7,500-$10,000 per year in additional interest. Over the life of the loan, this amounts to a substantial cost difference. Borrowers should evaluate whether improving their documentation position (for example, by amending tax returns or waiting to build U.S. credit history) could make agency financing available at a significantly lower total cost.

Documents You May Need

  • 12 or 24 months of consecutive bank statements (personal and/or business) for bank statement programs
  • Signed lease agreement or market rent appraisal (Form 1007) for DSCR loans
  • Two to three months of investment account statements for asset depletion programs
  • CPA letter confirming business existence and expense ratio (if required by the bank statement program)
  • Valid passport and visa documentation for foreign national programs
  • Letter of explanation for any recent credit events (bankruptcy, foreclosure, short sale)

Frequently Asked Questions

Are non-QM loans safe for borrowers?
Non-QM loans are regulated under the Dodd-Frank Act's Ability-to-Repay (ATR) rule, which requires lenders to make a reasonable, good-faith determination that the borrower can repay the loan. While they do not carry the QM safe harbor, they are not unregulated. Borrowers should understand the terms, compare options, and ensure the payment is sustainable within their financial situation.
Who typically uses non-QM loans?
The primary borrower populations include self-employed individuals whose tax returns understate cash flow, real estate investors who qualify based on property income (DSCR), retirees or high-net-worth individuals with assets but limited income, foreign nationals purchasing U.S. property, and borrowers with recent credit events who cannot meet agency waiting periods.
How much more expensive are non-QM loans compared to conventional loans?
Non-QM interest rates are typically 1% to 3% higher than comparable conforming rates, though the premium varies by program type, credit score, LTV, and market conditions. Points and fees may also be higher. Borrowers should compare the annual percentage rate (APR) across multiple lenders to assess the true cost difference .
Can I refinance out of a non-QM loan into a conventional loan later?
Yes, many borrowers use non-QM loans as a bridge to agency financing. For example, a self-employed borrower may use a bank statement loan for the initial purchase and later refinance into a conventional loan once two years of favorable tax returns are available. An investor may start with a DSCR loan and refinance into a portfolio loan at a lower rate. Planning the exit strategy at the time of origination is advisable.
What is the minimum credit score for a non-QM loan?
Minimum credit scores vary by program type and lender. Most bank statement and DSCR programs require 620 to 680. Some lenders offer programs at 580 to 620 for borrowers with compensating factors such as large down payments. Asset depletion programs may require higher scores in the 680 to 700 range. Foreign national programs vary widely .
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