By Alexandra Swan (NMLS 117371), Willow Bend Mortgage, 2019 Chair of CCAR’s Realtor/Lender Committee
According to the Texas Mortgage Bankers Association, 30% of Texans are self-employed. Fueled by a strong economy, a swelling population in North Texas, and a new tax law that rewards small business ownership- self-employed Texans are a growing part of our society.
As these entrepreneurs earn more money they often want to purchase real estate, but for the self-employed, buying a home or investment property can create a lot of challenges. The same tax advantages that allow the self-employed to keep more of their income by writing off their expenses become disadvantages at loan application. Traditional underwriting requires that buyers qualify off the adjusted gross income—after netting out claimed expenses. Traditional underwriting also sets limits on the number of financed properties an investor can own—making it more difficult to build wealth through real estate acquisition.
This does not mean that the self-employed are forever destined to rent. A growing group of loan products help self-employed borrowers qualify without using their tax returns or going through traditional underwriting. These products, broadly known as non-QM, (the QM stands for qualified mortgage) qualify borrowers based on their financial picture rather than narrowly-defined agency underwriting guidelines. To help your self-employed borrowers navigate this relatively new arena of non-QM mortgages, here’s what you need to know:
- Non-QM mortgages are not stated-income mortgages—at least not for primary residences and not in the traditional sense of the term. To comply with Dodd Frank the borrower needs to demonstrate ability-to-repay the loan. Some programs allow as little documentation as a one month bank statement along with a letter from the buyer stating the income, but most will require 12 months of consecutive personal bank statements or 24 months of consecutive business bank statements. Deposits will be averaged and unusual deposit activity will either be proven as income or subtracted from the total amount of deposits.
- No-income verification loans exist only for investment properties—and the property must really be used as an investment. That means that the borrower has to be able to prove that he has a primary residence elsewhere that he is going to continue to maintain after purchasing the rental property. The appraisal must support the future rental income of the property.
- “Reduced documentation” is a misnomer for these loan types. A few months ago, a LO in our company asked me a few questions about a bank statement loan he was preparing to submit. As I tried to go over the guidelines, he said rather dismissively, “It’s a bank statement loan—how many conditions can there be?” The short answer is –A LOT. Non-QM mortgages do not sell to the agencies—Fannie Mae, Freddie Mac, FHA, VA or USDA. They do not have mortgage insurance. They are portfolio loans underwritten to the guidelines of the lender who is offering them. These types of loans require extensive documentation and are time consuming and paper-intensive—it’s just DIFFERENT documentation and DIFFERENT conditions from the ones typically seen on a traditional mortgage loan.
- Interest rates and fees will be higher. Depending on the product being offered as well as the reason and type of mortgage loan, the interest rate may range from the high 5% range for a primary residence purchase with 25% down to the mid 7% range for an investor cash flow loan. Borrowers can also expect to pay higher underwriting fees, typically ranging from $1300-$1500.00 and may be charged between 1% and 3% as an origination fee. Non-QM loans represent a much higher risk to the investor (for the reasons listed in paragraph # 2 above) and that risk is priced into the rate and the fees.
- There may be a pre-payment penalty. Prepayment penalties were once common—today they are as rare as a dinosaur’s egg on most transactions. But non-QM investor cash flow loans typically require prepayment penalties.
- The appraisal and the quality of the collateral is REALLY important. The collateral is important on all mortgage loans, but in the case of non-QM loans, the property is the central piece of the loan. Expect more appraisal scrutiny, additional costs, and requirements for reviews.
- Not all non-QM loans are created equal. In fact, they vary pretty widely by lender. Many mortgage companies are now developing their own, in-house products, which compete with the better-known products already out in the market. Since these products are portfolio products, each lender sets their own underwriting guidelines and terms. That means that if one lender turns your loan down, chances are pretty good that you may still be able to find a home for it with a different lender.
Not every loan originator is skilled with non-QM loans. Likewise, not all originators have worked with multiple types of non-QM mortgages. If you have a buyer who needs a bank statement or non-QM mortgage, talk to the loan originator about the deal. Ask how many non-QM transactions he has done and what his comfort level is. Stay in communication with the loan originator and the borrower to make sure the borrower is furnishing the requested paperwork in a timely manner. Remember that the LO never asks for documentation for the sake of creating more work for the borrower. Getting the proper paperwork in on time is essential to a successful closing and funding.
For questions about how non-QM mortgages work, the types of loan products out there today, and the overall approval process, email CCAR’s REALTOR®/Lender Committee at [email protected]