Non-QM Purchase
Buying a home with a non-QM purchase mortgage loan is an option for many homebuyers of owner-occupant, second homes, and investment properties. Many homebuyers do not realize the benefit non-QM loans can be when you do not qualify for a traditional mortgage for one reason or another.
What Type of Mortgages Are Non-QM Purchase Loans
Homeownership has many rewards. Many people purchase their first home and live there happily for many years. Others live in their first home for a few years and decide they have outgrown it or it just no longer fits their needs.
What Is a Non-QM Loan? A Non-QM loan, or a non-qualified mortgage, is a type of mortgage loan that allows you to qualify based on alternative methods, instead of the traditional income verification required for most loans. Common examples include bank statements or using your assets as income.
Sometimes, it takes living somewhere for a length of time to figure out what features you would prefer in your home. Or perhaps you will keep your first home, and you are looking to buy a vacation home or an investment property.
Another scenario is that you or your partner need a commuter home as you live far away from your current job that relocated. You could also be looking to move an elderly parent closer or help your college graduate. It is essential to have clear goals when you decide to purchase a second home, as what the property is used for can affect which finance option will be best for you.
Additionally, the United States IRS may consider your home investment property, not a second home, if you rent it out for more than 15 days. This means that there are tax requirements because it is seen as an investment property.
Budgeting-Can You Afford a Second Home?
A financial advisor can assist you in determining if you can afford a second home, regardless of your intended plans for use. There are numerous ways to calculate if you are financially able to do so. Once you have found a financial advisor, they will look into your finances for indicators of what you can comfortably afford and ask questions such as whether or not your retirement funds are on track.
Can you afford the upkeep and maintenance on another home? We all know that maintenance on your primary property is quite expensive. Imagine having an entirely new property to maintain. Once you purchase a house, all repairs and upkeep are up to the owner. Will the new property have Homeowners Association (HOA) fees? Will you need to rent this home out to afford it financially? If so, this will not be a reliable source of finances to pay for it.
Finances – Upkeep and Costs of Owning a Second Home
When buying a second home, it will be different than your first property purchase. The lenders may be more stringent when looking for your finances, and you might need a higher credit score.
It would be best if you considered all costs involved in this purchase. If it is in addition to your primary home, you will have to pay two sets of utilities and taxes. You will need homeowners insurance on both properties. Additionally, as mentioned above, you will need to pay for maintenance and repairs on both. This includes lawn maintenance, snow removal, and general upkeep. This adds up and is quite costly.
What Is The Difference Between QM vs Non-QM Loans
Non-QM loans benefit borrowers who do not have a traditional source of income. The qualified income can be derived through other alternative means such as bank statement deposits, asset-depletion, or DSCR based on the property and not the borrowers.
A significant difference between a QM loan and a Non-QM loan is that a Non-QM loan uses alternative methods of income verification (vs. the standard income methods of verification of a QM loan) to help the borrower get approved for a mortgage loan.
Non-QM loans are not hard money loans or loans for bad credit borrowers. A large majority of non-QM borrowers are folks who have 700 FICO credit scores.
Most often, we find borrowers are in one of three situations that best fit a Non-QM loan: Self-employed borrowers with a lot of income tax write-offs. Borrowers with credit blemishes. Investors wishing to purchase rental or vacation home properties.
Many self-employed borrowers or independent business owners make a substantial income but do not qualify for a mortgage due to them taking the advantage of being self-employed which is unreimbursed business expenses. Non-QM loans are the best mortgage options for those who do not have traditional W2 income. There are dozens of non-QM and alternative mortgage loan programs in today’s market. Examples of popular non-QM mortgage options include bank statement loans, asset-depletion, no-doc loans, DSCR mortgages, ITIN, DACA, Foreign National mortgages, fix and flip loans, and other alternative no-income documentation loan programs.
When you are looking into a second property, as when you purchased your first, you need to have a grasp on what your credit report looks like. With some pre-planning and consciousness, you can correct a lower score. There are three major credit bureaus. They are Equifax, Experian, and TransUnion. There are several things that affect your score.
A credit report takes into account the types of credit and loans you have, the length of time you have had the loans, and your payment history. Your debt to credit utilization is how much debt a person has on their credit card divided by how much available credit you have on that account. Generally, lenders look for utilization of less than 30%.
If you have had delinquent payments, it will show up on your credit report. If this has happened, you can contact the lender and inquire about assistance in catching up. Late or missed payments on your bills is the number one factor in a low credit score. If you see dings on your credit report that are not accurate, you can dispute them through the credit bureau. This may signal an error or identity theft. The process of dispute can take time, so it’s important to know that it exists and give yourself the time to correct this before applying for a second home.
Most lenders will consider a credit score of 620 acceptable for most mortgages. It depends on what lender and type of loan you have, as there are options for individuals with lower credit scores. Most borrowers have a credit score of around 750. Fannie Mae, also known as the Federal National Mortgage Association, a mortgage investor, sets the acceptable score for a second home at 640 but requires a down payment of 25% or more, which is more than the typical 20% for first-home buyers. In many cases, it is essential to remember that the lower your credit score, the higher your interest rate.
Debt to Income Ratio
Your Debt to Income (DTI) Ratio is the percentage of your gross monthly income that goes towards paying your monthly bills and debt payments compared to your income. Included in this are your monthly mortgage payments, homeowners insurance, student loan payments, car payments, and minimum credit card payments. The typical debt-to-income ratio for a mortgage is 43%; however, when purchasing a second home, lenders will often want to see a better percentage.
Down Payment:
As stated above, Fannie Mae requires at least 25% down with second-home mortgages. These are for conventional loans, and Fannie Mae sets the guidelines. With a first mortgage, depending on which loan you go with, the down payment can be 3%-20%, even with no down payment in some scenarios. If you have built up equity in your primary residence, you may be able to borrow it to fund the down payment.
Using Equity From First Home For Buying Second Home
Home Equity Loan and HELOC
These options are considered second mortgages and new loans in addition to your existing ones. Keep in mind that this would mean two payments, with possibly two different lenders. A home equity loan will use the equity in your home to take a lump sum. You will pay this back over a set period, and it has a fixed interest rate.
A home equity line of credit (HELOC) uses a revolving line of credit. This is secured by the equity you have in your home, and you can borrow against it and repay within a “Draw Period .”Once this period is over, you will need to pay it back within a certain amount of time.
Cash Out Refinance
A Cash Out Finance is a primary mortgage and will usually have lower interest rates. You will replace your current mortgage with a larger one, so you can get cash out for the equity you have in your home. Closing costs can be higher for cash-out finance.
Second Home Requirements
Vacation Homes:
If the second home will be a vacation home, you must ensure that you meet lender requirements. These can include providing short-term rentals but no use of a management company. Additionally, it can’t be too close to your primary residence as it would not be considered a vacation home. The rule is that the vacation home must be at least 50 miles away from your primary residence in order to be considered a vacation property. You must live on the property for some years, and it must be able to function as a second home and be only one unit.
Investment Properties
A lender will consider an investment property a higher risk due to the possibility that a renter can invest less in maintaining the property and neglecting basic upkeep. There is also the chance that if you plan to rent out an investment property, there will be gaps in tenants. This could mean that you would have trouble making your payments. As stated earlier, a lender will want to see that you are not going to rely on income from the property to make the payment. Additionally, you can not get a VA or FHA loan for investment properties. They are only for primary residences.
Other ways to finance a second home
Jumbo loans
A Jumbo loan is basically larger than a standard loan. These loans can be used for primary homes, vacation homes, and investment properties. A jumbo loan is a non-conforming loan. This means that this type of loan does not meet the guidelines set to fit a typical loan limit. Limits are set by the Federal Housing Finance Agency, FHFA.
Conventional Loans
A conforming (meets the guidelines from Fannie Mae and Freddie Mac) conventional loan could be used for purchasing a second home; however, the home must be suitable to be occupied for all 12 months out of the year. Most lenders will describe a second home as a home that will not be rented out or used as a timeshare; you will live in it for at least 14 days out of the year and is a single-family home.
The home can’t be an investment property, and the owner only must be in control of the property (no management companies). You will need a credit score of at least 620, but some lenders require 725-750. Lenders also like to see significant cash reserves. Again, this is because second properties are riskier for the lender, especially if they are rental properties.
Investment Property Loans
An investment property loan is one that would allow you to produce income from either buying or building a home. You could do this by leasing out the property or by “flipping” it and selling it. Typically, the qualifications are stricter as lenders view investment properties as higher risk. You will be required by most lenders to have 20-30% down. Additionally, the mortgage interest on an investment property is fully tax-deductible. The rental income is taxable if the home is rented for more than 14 days per year.
Government loans are not really an option for a second home mortgage, regardless of how you use the property. These loans include USDA, FHA, and VA Loans. This is because the home would need to be a primary residence and not a second home or investment property.
Applying
Once you have worked on your credit report, talked with a financial advisor, and decided on which loan will best suit your needs, you are ready to apply. The application process for buying a second home is very similar to your primary residence. However, it is more stringent with requirements.
It would be best if you got preapproved for a loan, which will make the process much smoother once you find a property. Preapproval will bring to light any obstacles or issues that need attention. If you start the process fairly early, it can really help you keep things moving. It may also change how much home you think you can afford. If you can only get preapproved for a certain amount, it will narrow your choices for second home ownership.
You will need a real estate agent that can assist and advocate for you. Once your agent has helped you find your second property, you will make an offer. Sometimes, the sellers will counteroffer, which will be a negotiation. Once your offer is accepted, you are on your way to owning a second home! During this time, you will need to have an appraisal and an inspection completed on the property.
A home appraisal will ensure that the house is priced right, based on the area, the home itself, and the market value of others homes in the area. The home inspection is based on the physical house and is more detailed. This is when any issues come to the front, such as faulty wiring, a lousy furnace, mold, pests, etc. It usually takes about 30-40 days to close, sometimes longer if there are any snags along the way.
The closing costs associated with a second mortgage are comparable to a primary mortgage; however, the down payment is typically higher. Whatever the reason why you may want a second home- vacation property, investment, or a commuter home, there is a solution for you. All it takes is being aware of your financial status and credit score. Take the necessary steps and find professionals to guide you along the way!