Those loans for borrowers who don’t quite fit conventional financing standards — non-qualified mortgages or non-QM — have been on the upswing lately. Non-QM mortgages hit a low of 3% of the total mortgage market in 2020, according to one analysis by CoreLogic.
In the first half of last year, non-QM mortgages grew to 5% of the total mortgage market, or about one out of 20 loans, according to the analysis. Whether non-QM lending continues this trend this year depends on a variety of factors.
Like all loans, non-QM mortgages are interest-rate sensitive. If rates drop low, more borrowers will seek non-QM loans just as more borrowers will seek traditional financing. If rates rise too high, affordability challenges intrude just like for conventional borrowers. Non-QM borrowers may react differently to rate changes than traditional borrowers, however.
“In terms of sensitivity, in my view most of the non-QM borrowers … may prioritize the ability to secure financing over slight fluctuations in rates.”
Archana Pradhan, principal economist, CoreLogic
“In terms of sensitivity, in my view, most of the non-QM borrowers … may prioritize the ability to secure financing over slight fluctuations in rates,” says Archana Pradhan, principal economist at CoreLogic, who conducted the non-QM analysis.
Non-QM loans, which have been around for just more than a decade, don’t meet the strict criteria set by the Consumer Financial Protection Bureau to be purchased by the federal government or Fannie Mae or Freddie Mac. Non-QM borrowers do need to meet the ability-to-pay standard, however.
There are a wide number of non-QM loan products to meet a variety of borrower needs. Bank statement loans, for instance, can help self-employed individuals and gig-economy workers obtain a loan for a home by using deposits in the bank to verify income.
Debt service coverage ratio loans (DSCR), which use the cash flow of a property to determine the ability to repay, are popular among investors. There are non-QM loans for foreign nationals wishing to purchase property in the U.S. who can’t access agency loans.
One of the companies that has been taking advantage of the growth in non-QM lending as well as making these products a priority is CrossCountry Mortgage. Non-QM products often can be less risky from an underwriting standpoint than agency loans, says Glen Lemeshev, CrossCountry’s chief revenue officer.
He points to a lawyer leaving a firm to start their own practice or a medical professional striking out on their own to open an office. “All these things happen all the time and then effectively, that person becomes ineligible for financing for two or more years, traditional self-employed guidelines,” Lemeshev says.
For many of these borrowers, especially self-employed borrowers, the fact they are eligible for financing outweighs the slightly higher rates to come with non-QM mortgages. “Non-QM borrowers, at least for purposes of primary or second home transactions, are less rate sensitive, because they’re just excited to find out that they can actually get financed in the first place,” Lemeshev says.
One of the reasons for the recent growth in non-QM is because interest rates rose so quickly in the past couple of years, says Tom Davis, chief sales officer of Deephaven Mortgage, a non-QM lender. Originators had to add products and look to add alternative referral sources to Realtors to fill the refinance void, he says.
This has led some originators to start working with real-estate investors. About 28% of purchase transactions were made by investors in the fourth quarter of 2023, according to CoreLogic. Davis estimates that 40% of non-QM mortgages are DSCR loans to investors, including fix-and-flippers, who are helping with the housing inventory problems.
“We all know there’s a seller’s strike,” Davis says. “The vast majority of borrowers have mortgage rates well below where the market is today. People are not going to cash out of those low-end loans.”
Investor clients, however, may be more sensitive if interest rates climb, Pradhan says. These clients are paying more attention to the margins. If rates go up, the loans become more expensive. “It will make non-QM less attractive especially among the investors who might find a diminishing return,”
Pradhan says “There’s no point of getting a loan if you don’t get the return.”
Or as Lemeshev puts it: “Investors are paying a little more attention to the bottom line. If it’s going to cut too much into their bottom line, they’ll hold off if interest rates go up too much.”
But most prognosticators expect interest rates to decrease slightly in 2025 while remaining above 6%. And that should be a good thing for the non-QM market.
Lenders such as Deephaven and CrossCountry have made a priority of educating originators on the ins and outs of non-QM lending. And originators are in turn educating their referral partners that if conventional lending is turned down, that there are alternative financing options.
“These are all tools that an originator should have in their toolbox to serve their borrowers and the investor community,” Davis says. “If they don’t have these tools, they are at a competitive disadvantage.”
