Where The Money Comes From – QM, Non-QM and Everything in Between
Christopher Shank NMLS 2562885
Been doing a LOT of realtor outreach these last few weeks to talk about one of my favorite subjects, non-QM lending. On the whole, my conversations have been following a regular pattern:
“Howdy! I’m Chris Shank with Mortgage Advocacy. Yes, I am one of those crazy loan officers, but believe it or not, I’m not trying to sell you anything or beg for leads. Instead, I’d love an opportunity to share some information I have with you about non-QM lending and how it’s bringing some serious benefits to homebuyers and investors alike. Have a few minutes to chat?”
“Sure! Question for you though- what’s non-QM?”
Well, as is my rule, if I get asked to explain something enough, I’m going to get motivated to write it all out in one of these articles for posterity. So, that said, buckle up- we’re going on a bit of an adventure!
QM Lending
So, yeah, remember the Crash of ’08? Mortgage lending kind of caused that. You see, up until that point, the lending industry was a lot less regulated than it is now. Ever heard of a stated income loan? It was a loan that was somewhat prevalent in which the borrower simply told the loan officer how much they made each month without having to, you know, actually prove that they made that level of income. Ever go to a buffet and just load your plate up with pastries for the dessert section and then quickly find yourself unable to finish all 3.2 pounds of fat and sugar? Well, it was kind of like this, except instead of simply enduring the harsh glare of your waiter as they toss your folly into the garbage can, you’re enduring the dismay of having the banks repossess your home and forcibly ejecting your family onto the street.
As a result of this, quite a few loan officers and lenders found themselves on the wrong end of lawsuits. As the economy rebuilt itself over the next few years, the government decided to put a few laws in place to better control how mortgages are written in this country. Because of this, we have legislation like the Dodd Frank Act, which introduced a term called the “Qualified Mortgage”.
There are a lot of things that go into a QM loan, but the general theme is to incentivize lenders to make extra sure that their borrower can afford their loan and that unnecessary fees are left out of the process. In return, lenders will find it much easier to sell their loans on the secondary market. Additionally, government-backed loan programs like the FHA, USDA, or VA require the loan to be QM. As we’ve discussed before, these kinds of loans are very appealing to lenders because of the government-backed loss coverage, should the borrower default on their loan.
Non-QM Lending
Now that we know what a Qualified Mortgage is, we can define a Non-qualified Mortgage. Simply put, it’s a mortgage that does not comply with the standards for a QM. This makes these loans inherently riskier for the lender than QM loans, because if the borrower defaults on their loan, there is nobody who can come in and bail them out. In return for accepting a bit more risk, though, there is a lot less red tape when it comes to originating loans.
If you thought it was difficult to wrap your head around the various programs that fall within QM lending, prepare to have your mind boggled by the sheer breadth of different products available within the realm of non-QM. If you want to take out a HELOC or second mortgage to consolidate some debt, you’re looking for a non-QM loan. If it’s Monday and you need financing by Friday, you’re going to look for a non-QM lender. If you’re a business owner or 1099 who deducts as much from your income as possible to stay under that tax bracket, it might be a good idea to think non-QM. Fixing and flipping a house? Building a house? Investing with a DSCR? All non-QM products.
The driving force behind non-QM lending is, like most things in our economy, money. The lack of overbearing government restrictions on the world of non-QM lending is actually pretty enticing for private investors with a higher level of risk tolerance, especially if the lender they invest with specializes their book of business to ensure a thorough underwriting process to weed out unacceptable risks.
What about Hard Money Lending?
Prepare to dive further into the rabbit hole, folks! If you’ve looked into the world of investing, chances are you’ve heard the term “hard money”. Hard money lending is a type of non-QM lending, but not all non-QM lending is hard money. Make sense? If not, don’t worry- I’ve got you covered. Hard money lending is *usually* a short term bridge loan that uses real estate or other physical assets as collateral. In my experience, hard money is oftentimes used for fix and flip and construction loans. Instead of having to put 10% or 20% down to cover your share of the risk in such a venture, you instead could leverage the structure you’re fixing up, or the property you’re going to build upon.
In the grand scheme of things, hard money lending is usually the most flexible type of lending there is, as, in the words of one of my favorite investors “everything is on the table, so long as there’s a profit to be made”. Essentially- if you (or your trusted loan officer) can communicate your case effectively for your lender and the risk is acceptable, the structure of the loan itself can be molded to better fit the situation. Now, all of these benefits certainly come with a cost; should you default on your loan, the collateral you put in place (i.e. the property you’re working with) is at risk pursuant to the legal agreement that instantiated your loan.
Where do the Banks fit in with all of this?
Large financial institutions, such as banks and credit unions, oftentimes work with both QM and non-QM products. For example, your local bank may originate FHA and VA QM loans with the intent to sell them on the secondary market to turn a profit. At the same time, that bank could approve non-QM financing for construction loans.
Banks can do this because they tend to have quite the pool of capital to draw upon to back these transactions. Additionally, because the banks have the capital, they’re oftentimes in the position to dictate their own rates when it comes to financing. On the flip side, however, banks also have their own sets of rules with which they must abide from, both from the government’s side of things, and from their own shareholders and operating procedures. As a loan officer, I’ve seen some banks absolutely dominate in specific areas of lending while being completely incapable of competing in others. I’ll certainly never tell you to avoid shopping with your bank, especially if you have a good relationship with them. That said, every organization has its own risk tolerances, and sometimes despite how powerful a bank’s products may be, they simply lack the agility to compete against an entire industry of specialized lenders.
It’s Example Time!
I know I’ve dropped a lot of info on you over the last few minutes, so I want to lock this all in place by giving you a few historical examples as to how I’ve seen this spectrum in action.
Qualified Quinton
Quinton just PCS’d to Fort Campbell and decided that he does not want to live on base housing. He receives regular pay from the Army and gets a housing allowance from the government. In my opinion, the VA loan is the king of all QM programs, so it’s a no-brainer that he looks into securing himself a VA loan. Because of its well-known features, he was able to buy his first home with $0 down. He also had his seller pay for all his closing expenses.
Nancy the Realtor
Nancy is a realtor and is paid as a 1099. Last year, she made over $250k from selling houses, but through the efforts of an awesome tax professional, she managed to depreciate and deduct her income to the point that she only reported yearly earnings of around $30k to the IRS (all totally legal). Unfortunately, when it came time for her to qualify for a conventional loan, her debt-to-income ratio using that $30k yearly income meant that she could only qualify for a house purchase in the $120k range (a tad low for Clarksville). Luckily, using a non-QM bank statement loan, we were able to use an alternate method of verifying her income and was able to pair her with a lender who set her buying power over $900k.
Danny the Developer
With building costs under $150/sqft, Danny has decided that instead of flipping houses, he wants to build them from the ground up and sell them for a massive profit. He doesn’t have a lot of money with which to invest, but he managed to work out a deal with a local landowner with which Danny will be added to the title, develop the land, build some homes upon it, sell those homes, and then pay the original landowner back a cut of the proceeds. Danny shopped through a few different lenders (including a pair of banks), but ultimately settled on a hard money lender because they allowed him to collateralize the land he was now titled on in order to secure financing to build with minimal financial investment on his part.
Bucky Big Bucks
Bucky has been a long time client of his bank and even has them manage his investment portfolio of several million dollars. Bucky is of the mind to purchase himself a winter home down in Florida, as his wife hates even the thought of snow. Bucky’s bank originally gave him a rate that was pretty similar to those of the other lenders he got quotes for. Slightly miffed, he leveraged his relationship with the bank (including his investment portfolio) and insisted upon a better deal, or else he would have to take his business (and that portfolio) elsewhere. The bank decided that rather than loose all of Bucky’s business, they had the capital to take a minor hit and gave him a rate on his new loan that could not be beat elsewhere.
Summary
Well folks, there you have it. At best, you’re now more slightly capable of leveraging this information to secure a more advantageous financial position for you and your family during your next financing adventure. At worse, you’ve now got a few new tidbits to stump your friends at your next social gathering! If you’re feeling at all perplexed, please don’t associate any negative feelings to it. There’s a lot to the wide world of financing, and you’re certainly not expected to know it all. It’s for this reason that I highly recommend snagging yourself a guide or trusted advocate when it comes to ensuring that you’re getting the absolute best representation whether it comes to your first or fiftieth foray into financing your future.
