Homebuyers

Forget the Myths You’ve Heard. If You’re Self-Employed, You May Still Be Able to Buy a Home

For many people, being self-employed is the dream. They don’t have to answer to anyone—except potentially their clients.

However, there can be some downsides, including fluctuating income. This can make it harder for many small business owners, freelancers, gig and contract workers as they may struggle to get a traditional mortgage.

That’s where non-qualified mortgages, often known as non-QM loans, come in. These loans are tailored for folks who don’t receive a W-2 tax form or don’t meet traditional income documentation requirements.

Unfortunately, there are a lot of myths and misperceptions surrounding these loans. This may prevent those who need these loans the most from applying.

“Non-QM loans open the door for people who don’t fit the traditional one-size-fits-all mortgage box,” said Rau Hernández, a New American Funding branch manager based in Orlando, Fla. “[T]hey help people who are financially strong, but don’t check every conventional [loan] underwriting box.”

Below, we’ll address some of the most persistent non-QM loan myths head-on and show how non-qualified mortgages may help you become a homeowner.

What are non-qualified mortgages?

Qualified and non-qualified mortgages are relatively new concepts.

The Consumer Financial Protection Bureau (CFPB) introduced qualified mortgages in 2014 to eliminate potentially risky loan features. These features included balloon payments, when your mortgage payments rise dramatically, and negative amortization, when you’re paying off your loan but the amount you owe is growing.

But qualified mortgages also have guardrails limiting how lenders can evaluate a borrower’s ability to repay their loans.  

Freelancers, entrepreneurs, gig workers, and other self-employed individuals typically can’t meet these requirements, despite potentially making more money than traditionally employed individuals.

Enter non-qualified mortgages, which don’t adhere to the CFPB’s provisions.

Non-qualified mortgages, also called non-QM loans, are often good for self-employed borrowers. They may also be a good choice for:

• Real estate investors who do fix-and-flips
• Foreign nationals without credit scores
• Borrowers who have significant financial assets but avoid credit cards. These individuals may not have the credit score to qualify for a qualified mortgage.

Unfortunately, there’s a lot of misinformation about non-QM loans that might discourage you from considering this path to homeownership.

Myth 1: Non-QM loans are high-risk mortgages

Those who lived through the Great Recession in the 2000s may shudder at the term “non-qualified mortgage.” But non-QM loans are nothing like the subprime mortgages that were common 20 years ago and got many homeowners in trouble.

Those loans were riskier and frequently required little or no documentation.

“Today’s non-QM loans are nothing like the subprime era,” said Hernández. “These loans still require solid credit, strong down payments, and a real ability to repay.”

For instance, lenders require thorough documentation for non-QM loans, such as bank statements and tax returns, and have limits on how much debt borrowers can have to qualify for these loans.

Lenders generally require a credit score of 660 or higher for non-QM loans. There are typically debt-to-income ratio (DTI) limits of 45% to 55% for these mortgages as well.

Myth 2: Self-employed borrowers will have trouble qualifying for non-QM loans

Self-employed individuals, such as freelancers, gig workers, and small business owners, face more hurdles securing a mortgage than traditional borrowers (i.e., those with salaried jobs with W-2s). The biggest concern from lenders is these borrowers have income that may fluctuate.

But that doesn’t mean it’s impossible to get a mortgage.

Non-qualified mortgages are designed with people like self-employed individuals in mind.

“Non-QM loans allow individuals access to longer-term mortgage financing who might not qualify for traditional loans, such as self-employed individuals and entrepreneurs,” said Ken Johnson, chair of real estate at the University of Mississippi.

Rather than provide W-2 tax documents, these borrowers typically need to demonstrate two years of stable income as a self-employed person. Lenders typically verify your income by reviewing:

• Tax returns
• 1099s
• Bank statements
• Investment account statements
• Profit and loss statements

Lenders will also review your credit score and assess your debt-to-income ratio.

Myth 3: Non-qualified mortgages have extremely high interest rates

Critics of non-qualified mortgages often cite exorbitant interest rates as a reason to steer clear of these loans. However, rates may not be much more than they are for 30-year fixed-rate mortgages.

Fact: Rates for non-qualified mortgages are typically a percent or two higher than they are for traditional mortgages, according to Fitch Ratings.

“Non-QM loans are riskier [for lenders] than traditional home loans, and the rates reflect this,” Johnson explained.

While not ideal, such rates aren’t dramatically higher and shouldn’t be a reason for borrowers to skip out on buying a home altogether.

Down the road, if the borrower’s situation changes, such as if they get a salaried (W-2) job or improve their credit score, they may be able to refinance the mortgage for one with a lower rate.

And in case you’ve heard another common non-qualified mortgage myth, that you can’t refinance a non-QM loan, this isn’t true. Refinancing is an option.

Myth 4: You need a large down payment for non-QM loans

There’s some truth to this: Non-QM loans will likely require a larger down payment than other types of mortgages. But down payment requirements for non-qualified mortgages may not be as large as you think.

Each lender will have its own requirements. While it’s true that some non-qualified mortgages may require 20% or even 30% down, other lenders may allow you to qualify with as little as 10% down.

Plus, a larger down payment may be a good thing for a non-QM loan, according to Johnson.

“With a large-enough down payment, [mortgage] rates will equalize between non-QM and traditional loans,” he said.

Lenders view substantial down payments as an indication of financial responsibility. When lenders view you as less of a risk, mortgage interest rates tend to reflect that.

Rau Hernández NMLS # 619301