Ability to Repay (ATR)

Non-QM loans are often those that contain specific product features that Congress and the CFPB prohibited for Qualified Mortgages (QMs) because they were associated with high default rates prior to the financial crisis. These prohibited features include:

• Negative amortization (where the principal balance increases).
• Interest-only payments.
• Balloon payment clauses (except in existing limited circumstances).
• Loan terms exceeding 30 years (Non-QM options may extend to 40 years).
• Total points and fees exceeding specific limits (typically 3% of the total loan amount, subject to small loan adjustments). 

Non-QM loans generally permit these features, provided the lender can still demonstrate compliance with the fundamental ATR rule

Non-QM loans leverage flexible underwriting standards to provide credit access for creditworthy individuals who cannot meet conventional QM requirements. Key borrower segments include:

• Self-Employed Individuals and Gig Workers: Those who use business write-offs or have complex income streams that understate their true earning power on tax returns.
• Real Estate Investors: Individuals seeking to qualify based on the investment property’s cash flow (DSCR) rather than their personal DTI ratio.
• Borrowers with Recent Credit Events: Consumers recovering from bankruptcy, foreclosure, or short sale who may qualify with a minimal seasoning period (sometimes as short as one day out).
• Retirees and High-Net-Worth Individuals: Those with substantial assets or dividends who may have limited recurring income as verified by W-2s.

Non-QM loans carry increased exposure for lenders regarding ATR compliance because they lack the conclusive legal protection afforded by the QM safe harbor.
If a creditor fails to make a reasonable, good-faith ATR determination:

• Civil Liability: The creditor could be liable for actual damages, statutory damages, legal fees, and special statutory damages equaling all finance charges and fees paid by the consumer for up to three years.
• Defense to Foreclosure: Aggrieved borrowers may raise ATR violations as a defense by way of recoupment or set off with no time limit, even if the foreclosure is non-judicial.
• Market Risk: This perceived litigation risk has been identified as a factor leading to sharp reductions in access to credit for certain loan segments, demonstrating lender reluctance to operate outside the certainty of QM status.

Because Non-QM loans cater to borrowers whose income may not be easily documented by W-2s or tax returns (such as self-employed or gig workers), they rely on alternative documentation to meet the ATR requirement for verified income and assets. Common methods include:

• Bank Statement Qualification: Evaluating 12 to 24 months of personal or business bank statements to derive qualifying income and document cash flow.
• Asset Depletion (Asset Qualifier): Utilizing strategies where substantial liquid assets (like stocks, bonds, or retirement accounts) are converted into a monthly qualifying income stream.
• DSCR (Debt Service Coverage Ratio) Loans: Qualifying real estate investors based on the property’s expected rental income covering the debt service, rather than verifying the borrower’s personal income or DTI.

Unlike Qualified Mortgages (QM) which receive a presumption of compliance with ATR (either a safe harbor or rebuttable presumption), Non-QM loans forego this specific legal protection. Non-QM lenders must still comply with the ATR rule by diligently considering eight mandated underwriting factors, which include DTI or residual income.
This approach grants lenders flexibility in applying their own underwriting standards. Crucially, while General QM loans cap the DTI ratio at 43%, Non-QM lending allows for higher DTI ratios (often up to 50% or more) as long as the lender makes a reasonable, good-faith ATR determination based on the facts and circumstances.

The fundamental requirement for all residential mortgage loans, including Non-QM loans, is the Ability-to-Repay (ATR) rule, mandated by the Dodd-Frank Act. This rule requires the creditor to make a reasonable and good faith determination, based on verified and documented information, that the consumer has a reasonable ability to repay the loan according to its terms, along with applicable taxes, insurance, and assessments. The requirement applies to most closed-end mortgage transactions secured by a dwelling.