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   ARTICLE   |   From Scotsman Guide Residential Edition   |   January 2015

Who Benefits From Alternative Lending?

Non-qualified mortgage products offer opportunities and challenges for brokers and borrowers

Who Benefits From Alternative Lending?

In the past year, non-qualified mortgage (QM) products emerged, catering to borrowers who don’t meet the tighter mortgage requirements in the wake of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These products offered by banks, new investors and even municipalities provide opportunities and challenges for the entire marketplace.

The QM and the ability-to-repay (ATR) provisions were enacted by the Consumer Financial Protection Bureau (CFPB) to protect borrowers, but they have disenfranchised many. A debt-to-income (DTI) ratio over 43 percent — along with other qualifying requirements — is relatively low. Emerging non-QM products allow higher DTIs, credit blemishes and alternate document types. Non-QM lenders put more reliance on assets and reserves, as well as lower loan-to-value (LTV) ratios, to mitigate their risk.

These products have higher rates, however, so they cost more over the life of the mortgage than Fannie Mae and Freddie Mac loans. This puts borrowers in a worse financial position than they would have been prior to the QM and ATR provisions.

These products create opportunities for property investors. Companies formulate these products around the idea that property investors are normally more financially secure and informed about the market. Some products use just cash flow from properties, others allow unlimited financed properties and still others allow lower FICOs. Because of multiple financing and other investment property issues, these borrowers may suffer dramatic drops in their credit scores, thus blocking them out of Fannie and Freddie financing.

Several groups of borrowers may be able to reap some benefit from the emergence of non-QM loan options if and when the industry begins to loosen credit restrictions. The industry faces a number of issues catering to these groups, however.

Millennials

This often-discussed segment of the population presents a unique challenge. How can millennials be lured to jump more aggressively into the housing market? Memories of what their parents experienced in the financial meltdown makes for a steep slope to climb for the industry.

All the regulations coming out of the CFPB regarding QM and ATR requirements push access to housing even further out of reach of millennials. With the continued aggressiveness of private investors and banks, however, it may not be long before a tailored program outside of the QM and ATR requirements will specifically target millennial first-time homebuyers.

Millennial credit is still relatively fresh. This demographic usually has no foreclosures or bankruptcies, and its future earning potential is vast. The products will have to be financially friendly, however, because setting up a new homeowner to fail is not something the industry wants to do. This is where temperance needs to be heeded. Millennials can be a great resource for continued healing of the housing market, but not at the expense of another financial meltdown.

Boomers

Baby boomers are already enjoying a tailored program, the Home Equity Conversion Mortgage (HECM), or reverse mortgage. A majority of baby boomers are either retired or close to retirement, so using equity to finance retirement is a great option. Unfortunately, although reverse mortgages have been widely available for some time, they still hold a stigma to those who remember the first rollout of this program and all the legal issues that resulted.

Reverse mortgages may be a hard sell for some loan originators, but if they use due diligence and explain to potential clients that using a HECM is not a sign of failure to plan for retirement — nor will they or their heirs have the property pulled out from under them — then the process should take most of the previous stigma away.

This program is a great opportunity for baby boomers — who get to use their existing equity and not worry about mortgage payments — as well as an excellent referral source for loan originators. Most of the challenges in HECMs have been weeded out and resolved, so the downside is limited. The inclusion of required counseling for this product has helped make it a winner.

Generation X

Generation Xers shouldn’t be forgotten. These are homeowners who were caught in the middle of the financial crisis. Many of them experienced losing their homes, trying to get modifications, being underwater on their mortgages and waiting for improvement in the market.

Although attempts have been made to resolve the latter issues with the Home Affordable Refinance Program and Home Affordable Modification Program, many Gen Xers still remain outside the box, including those who experienced foreclosures, short sales and modifications. New alternative credit products are available for these borrowers, with the selling point being that some only require a seasoning of 12 months to one day out of foreclosure.

These programs are aggressive and they have a huge cost factor. Questions also remain about their risk level, as well as the burden on the borrower. Are they right for borrowers? Yes and no.

For borrowers who couldn’t save their homes because of unfortunate circumstances or bad timing, but who still have assets for large downpayments and substantial reserves after close, this could be a great way to buy a home and start a positive mortgage history. They can then refinance to a lower rate at a later date.

These programs are not for home-owners who went into foreclosure because of financial mismanagement, however, or those who don’t have assets for large downpayments and large reserves. Therefore, weigh carefully the benefits, or lack thereof, for each borrower.

Neighborhood improvement

Other groups also are being served by municipality funding through neighborhood improvement-like “silent second” mortgages, or teacher- and police officer-assistance programs. These communities have recognized that offering incentives will help lower their foreclosure inventory and bring in new property tax revenues.

Many communities lost a huge portion of real estate tax revenues during the financial crisis and the tidal wave of foreclosures that followed. This is old news, but savvy city and county managers now realize that using extra general funds to finance mortgage-funding programs is a small investment that will pay off big in the coming years.

The attraction for homebuyers is that strengthening a municipality’s infrastructure will benefit them and their families as well. An increased tax base can fund better schools, new parks, road improvements and community events, and even help attract new businesses to service the rebuilding of the community.

Although some alternative lenders may not allow these silent seconds, Fannie and Freddie do under the Neighborhood Stabilization Program. Depending on the program, there may be reduced payments, deferred payments or no payments at all, so consider this when qualifying your borrower. These payments should be included in the DTI.

When more communities get comfortable with these incentives, borrowers will have more options in the areas they want to live. State-funded programs are also seeing additional funding to help their own residents and even attract residents from other states to relocate.

•  •  •

The mortgage industry continues to evolve, devolve and mutate to accommodate new challenges and open new opportunities. It can never be said that the industry as a whole has ever stood still. Although not everything has worked to the benefit of borrowers, most of it has allowed qualified ones the opportunity to feel pride of ownership because of creative, smart and talented individuals from local loan originators all the way up to Wall Street.

Loan originators have a growing menu of products to help borrowers, but these need to be used wisely. Borrowers who are pushing the max in credit score, reserves, LTV and DTI ratios, and other areas would probably benefit from homebuyer counseling and waiting until they are in better shape financially. You can have all the great programs in the world, but if they don’t result in putting your borrower in a positive position, you should rethink whether to proceed or not. 


 


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