Most everyone who has gotten or currently have a mortgage, are familiar with the standard documentation process as it relates to the applicant. Lenders want to make sure the potential borrowers can comfortably afford the new mortgage payment (including taxes, insurance and mortgage insurance when needed). They primarily do so to calculate debt-to-income ratios. If a loan program asks the housing debt ratio to be 30, that means the total housing payment should be at 30% of the applicant’s gross monthly income. Lenders ask for the most recent paycheck stubs covering a 30 day period, the last two years of W2 forms, the last two years of tax returns from the self-employed borrower as well as bank statements to verify there are enough assets to cover the down payment, closing costs and cash reserves.
Back in 2014, the Federal Housing Finance Agency, or FHFA, set guidelines for what is now known as ‘Qualified Mortgage,’ or ‘QM.’ When a mortgage loan meets the guidelines for a QM loan, the lender is then able to be shielded from any lawsuits from borrowers as well as to set standards that would help prevent a repeat of the subprime mortgage crisis that hit the country. Most mortgage loans issued today fall into the QM category. But there are other important ‘niche’ type programs that serve other sectors of the real estate finance industry. These programs are ‘Non-QM, Bank Statement and Debt Service Coverage Ratio Loans (DSCR). What are these programs and what are the advantages they offer?
A non-QM loan is, obviously, a loan program that has guidelines outside the ones for QM financing. For example, a QM loan prohibits loan terms greater than 30 years. A non-QM loan however can extend the repayment period to 40 years. Extending the loan term means lowering the monthly payments on the very same mortgage. A non-QM loan will accept ‘interest only’ payments. An interest only loan means the borrowers have the option each month of paying the full mortgage payment or just the interest each month. An interest only loan results in a lower monthly payment which boosts borrowing power. It is also an excellent choice for those who receive income on an irregular basis. A self-employed borrower might not receive a paycheck on the 1st and 15th of every month, but gets paid when their clients pay.
A type of non-QM loan program that caters to the self-employed is the Bank Statement program. This program uses bank statements to calculate income in lieu of tax returns. The bank statements will show deposits into the business account that come from the applicant’s clients. Instead of tax returns, a bank statement loan adds up the deposits that appear each month and then averages those amounts to arrive at a qualifying income.
A debt service coverage ratio loan, or DSCR, is one where the lender calculates the net operating expenses for the business by subtracting gross monthly income all expenses. A DSCR loan is used for investment properties and has a set DCSR for each program. If for example a DSCR loan has a loan program that features a 1.20, that means the income must be 1.2 times the monthly mortgage payment. If the mortgage payment were $5,000 and the DSCR 1.2, the income must be 1.2 times $5,000, or $6,000.
Note that non-QM mortgages do not mean loans for those with damaged or non-existent credit but instead of group of programs that cater to borrowers that may not have otherwise qualified based upon traditional, QM guidelines.