The Mortgage Waterfall Test
Test borrowers against progressively broader mortgage options
- Difficulty
- Easy
- Time to result
- ~days to results
- Steps
- 5
- Confidence
- 96%
The Mortgage Waterfall Test is Tan Karim's method for placing a borrower by checking loan routes in a deliberate sequence. The originator starts with conventional or FHA qualification, then moves down through bank-statement and profit-and-loss options before considering the Community Mortgage or hard money. Each stage asks whether the borrower fits that route, allowing the originator to stop once a suitable option is identified. The mechanism combines speed with product breadth: instead of treating a non-QM lender as a one-product destination, the broker maps the borrower's income and documentation to progressively broader alternatives. Karim says the initial identification should take only a few minutes, while the eventual loan still requires efficient execution and underwriting.
Origin
Tan Karim says he has taught the Waterfall Test for five years in presentations to processors, loan officers, and brokers.
Core principles
- 01Start with the most conventional suitable option
- 02Move through alternatives in a fixed order
- 03Identify the borrower's fit quickly
- 04Use broader products only after narrower tests fail
How to run it
- 1
Test the conventional route
Begin by checking whether the borrower fits a conventional or FHA loan rather than assuming they need a specialist product.
Pro tip Establish the borrower's down payment, income documentation, and standard qualification position first.
Watch out Do not send every borrower directly to the broadest non-QM option.
- 2
Check bank-statement qualification
If the standard route does not fit, determine whether personal bank statements can document the borrower's cash flow.
Pro tip This route can fit self-employed borrowers with money coming in but tax returns that do not reflect their usable cash flow.
Watch out Confirm the current lender requirements rather than assuming every bank-statement product works the same way.
- 3
Evaluate a P&L loan
Next, assess whether a profit-and-loss statement offers a workable qualification path for the borrower.
Pro tip Check whether the lender requires bank statements to support the P&L, because Karim says Change's product did not.
Watch out Do not treat a P&L as sufficient without checking the applicable product guidelines.
- 4
Consider no-documentation lending
If the earlier options fail, test the borrower against the Community Mortgage or another applicable no-income-documentation product.
Pro tip Review credit, collateral, reserves, loan purpose, and loan-to-value against the current program rules.
Watch out The guidelines discussed in this episode were a product announcement from May 2024 and may have changed.
- 5
Assess the final alternatives
Only after testing the earlier routes should the originator consider hard money or another last-stage option.
Pro tip Explain why each earlier route did not fit so the final recommendation remains transparent.
Watch out A quick product classification does not replace underwriting or suitability review.
In the wild
A young self-employed buyer does not meet normal FHA guidelines and has income from several activities. The originator first rules out the standard route, then checks personal bank statements before moving to broader products. If 12 months of statements adequately show money coming in under the applicable program, the borrower can stop at that level of the waterfall rather than defaulting to a no-documentation loan.
→ The borrower is matched to the earliest suitable route in the sequence.
A doctor or dentist owns a practice, is rate-sensitive, and does not fit the first standard test. The broker checks a jumbo bank-statement loan and then a P&L loan before considering the bottom of the waterfall. This uses the lender's wider product set instead of treating it only as a source of no-income loans.
→ The broker tests a potentially better-fitting documented product before using a broader alternative.
Common mistakes
Starting at the bottom
Going straight to the Community Mortgage skips products that may fit the borrower earlier in the sequence.
Knowing only conventional products
An originator who understands only tax-return, W-2, FHA, and VA borrowers may miss viable non-QM routes.
Confusing placement with approval
Identifying a likely product in a few minutes does not remove the need for current guidelines and underwriting.
Is it for you?
Best for
It is best for mortgage originators assessing borrowers whose income or documentation may not fit standard underwriting.
Not ideal for
It is not a substitute for current lender guidelines, underwriting, or a complete borrower assessment.
From the transcript
“I've always taught processors loan officers Brokers you name it you know the waterfall test”
“don't go straight to the Community Mortgage”
“it should only take a few minutes to really understand and identify where your borrower falls on that on that fall test”
From the episode
How Much Mortgage Can I Afford ft. Tan Karim
Tan Karim