Temporary QM: The second type of QMs are certain loans originated during a transitional period that are eligible for purchase or guarantee by Fannie Mae or Freddie Mac, or for insurance or guarantee by certain federal agencies. The QM patch was created by the CFPB as a 'patch' to the Qualified Mortgage rule for Fannie Mae and Freddie Mac borrowers. It ends in 2021. Learn more here.
© Art Wager/Getty Images Art Wager/Getty ImagesDuring the early days of the coronavirus recession, the market for non-qualified mortgages ground to a halt. In recent months, however, non-QM loans have returned as an option for self-employed borrowers who don't qualify for mainstream mortgages.
'The industry obviously took a beating,' says Raymond Eshaghian, president of GreenBox Loans, a non-QM lender in Los Angeles. 'But in the last few months, we've seen that market bouncing back.'
Angel Oak Home Loans, a non-QM lender in Atlanta, reports a similar trend. Investors shunned non-QM loans in March and April as too risky. But with the housing market holding up well during this recession, mortgage investors — who dictate the availability of non-QM loans — have reversed course.
© Art Wager/Getty Images suburban neighborhood'It's not back to full volume, but it's close,' says Mac Cregger, senior vice president and regional manager at Angel Oak.
What are non-QM mortgages?
Non-QM loans sport a jargony name that only a bureaucrat could love. The concept of qualified and non-qualified mortgages grew from the regulatory response to the housing crash.
When the mortgage market melted down in 2007 and 2008, the primary culprits were 'liar loans,' stated-income loans and other fast-and-loose mortgages that approved borrowers for risky debt. In the aftermath of that debacle, the Consumer Financial Protection Bureau in 2014 sought to marginalize exotic mortgages.
The QM rule requires lenders to offer loans with features that protect borrowers from mortgages they can't afford. There's still some wiggle room, though, and that's where non-QM loans come in.
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A borrower taking a loan that will be bought by Fannie Mae or Freddie Mac provides pay stubs, tax returns and bank statements as part of the approval process. A non-QM borrower, on the other hand, typically submits only bank statements.
Cregger points to quirks in the tax treatment of business expenses. To lower their tax bills, entrepreneurs use business expenses to offset their income. However, that practice might not make their tax returns attractive to lenders.
Cregger offers the example of the owner of a plumbing business — with his fleet of trucks and roster of employees, his tax return shows hefty expenses and not much profit. 'On paper, he may not look like the guy making $1 million,' Cregger says.
Instead of scrutinizing tax returns and pay stubs, non-QM lenders focus on borrowers' bank statements. As of mid-September, Angel Oak was offering bank-statement loans for as much as $3 million to borrowers with credit scores as low as 660.
A niche offering
One obvious downside to non-QM loans is their cost. At a time when rates on Fannie and Freddie loans are at record lows — below 3 percent — rates on these specialty mortgages are typically more than 5 percent. That explains why non-QM loans remain a niche product.
'When I talk about non-QM loans, I refer to them as less than 4.5 percent of all loans done in America,' says Logan Mohtashami, lead analyst for HousingWire.
Even if the market for non-QM loans is small, the mortgages play an important role, say proponents of non-QM loans. Before the coronavirus pandemic struck the U.S. in March, non-QM loans were the fastest-growing segment of the mortgage market, Angel Oak says.
With more and more Americans working as independent contractors, many borrowers struggle to get approved for qualified mortgages. 'There is a large percentage of loans that don't fit in that box,' Cregger says.
And the box seems to be getting smaller. In June, Fannie Mae and Freddie Mac, the government-backed companies that buy most of the mortgages issued in the U.S., began requiring additional paperwork from self-employed borrowers. The agencies want borrowers to provide year-to-date profit and loss statements that show revenues, expenses and net income so far in 2020.
Learn more:
At the moment, there are three main types of Qualified Mortgages, as outlined by the Consumer Financial Protection Bureau (CFPB).
Let’s explore the definition of each of them to see what’s available in today’s marketplace.
Type 1: General QM Loans
So-called “General QM loans” may not contain negative amortization, interest-only, or balloon-payment features. Additionally, they may not have a loan term that exceeds 30 years.
These loans must be underwritten using a fully-amortized payment with the maximum interest rate permitted during the first five years after the date of the first payment.
Underwriters must consider and verify consumer’s income or assets, current debt obligations, and alimony/child support obligations (if applicable).
The borrower’s monthly DTI ratio may not exceed 43%. However, mortgages eligible for purchase or guarantee by the FHA, VA, or Rural Housing Service (USDA loans) do not have a maximum DTI requirement, and are considered Qualified Mortgages by virtue of the regulations issued by those agencies.
Lastly, the points and fees on QM loans may not exceed the points-and-fees caps established under the rule, which is generally 3% of the total loan amount.
[What are non-QM loans?]
Type 2: Temporary QM Loans
Loans that meet the “Temporary QM” definition must meet all of the same requirements as the General QM loans.
Additionally, they must be eligible for purchase or guarantee by Fannie Mae or Freddie Mac
However, they are not subject to the 43% maximum DTI ratio threshold that applies to General QM loans.
This category of QM loans will expire by no later than January 10, 2021, but likely earlier once the GSEs exit federal conservatorship and the specified federal agencies own QM rules take effect.
Type 3: Small Creditor QM Loans
The final category deals with QM loans made by small creditors that are held in their own portfolio.
An organization is considered small if it has less than $2 billion in assets and originates fewer than 500 first-lien mortgages per year.
They have the same requirements as General QM loans, though there is not a specific DTI limit (however, it still must be verified).
Balloon Payments & QM
There are also a couple of subcategories of QM loans under the small creditor umbrella that allow for a balloon-payment feature.
These types of loans can only be originated if more than half of the organization’s first-lien covered transactions in the prior calendar year have been secured by properties in rural or underserved areas.
However, small creditors will be able to offer balloon payments until January 10, 2016 even if they don’t meet the rural/underserved quota.
Safe Harbor vs. Rebuttable Presumption
Importantly, the Dodd-Frank Act provides that ‘‘qualified mortgages’’ are entitled to a presumption that the originating lender satisfied the ability-to-repay (ATR) requirements.
However, there are two different types of legal presumption of compliance, including conclusive (safe harbor) and rebuttable.
In the case of safe harbor, a borrower cannot challenge whether the bank or lender met its ATR obligation. This is most desirable outcome for the lender, so they will strive to originate so-called “Safe Harbor QMs” if at all possible.
As the rebuttable name implies, the borrower has the ability to challenge the lender’s compliance with the ATR rule, but must still provide evidence to attempt to rebut that presumption.
The APR of the loan is used to determine compliance type. QMs that are not higher-priced have a safe harbor.
QMs that are higher-priced have a rebuttable presumption, as defined by:
- A first-lien mortgage for which, at the time the interest rate on the loan was set, the APR was 1.5 percentage points or more over the Average Prime Offer Rate (APOR)
- A subordinate-lien mortgage with an APR that, when the interest rate was set, exceeded the APOR by 3.5 percentage points or more
For example, if the APOR is 5%, a first mortgage with an APR of 6.5% or higher would be considered higher-priced.
And a second mortgage with an APR of 8.5% would also be higher-priced.
Meanwhile, a Small Creditor or Balloon-Payment QM is higher-priced if:
- The APR when the interest rate was set exceeded the APOR by 3.5 percentage points or more, for both first-lien and subordinate-lien mortgages
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Note that FHA loans have a different definition of higher-priced. The APR cannot be more than 1.15% plus the annual MIP above the APOR.
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In late 2020, a similar type of QM was proposed, known as a Seasoned QM.
(QM definition source: CFPB)
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Update: Just months after the rules were implemented, many lenders have begun offering non-QM loan products to take advantage of business that falls outside of these QM definitions.