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   ARTICLE   |   From Scotsman Guide Residential Edition   |   June 2018

Don’t Let Declining Loan Volume Get You Down

Non-agency loans can help originators offset the shrinking refinance market

r_2018-06_schaefer_spot.jpgHistorically low mortgage rates from 2010 to 2017 fueled a tidal wave of home refinances. With rates now finally normalizing, a shrinking refinance market is causing lenders to shift their focus to the home-purchase market.

While the traditional home-purchase market is one way to recoup lost loan volume, it can be an arduous climb. Another option, and possibly a superior one at that, is exploring the relatively untapped potential of alternative-loan products.

Industry professionals are typically well-versed about loans that meet the standards of the qualified-mortgage (QM) regime. A QM loan is required to meet certain underwriting requirements for lender protection and for securitization in the secondary market by government-sponsored enterprises (or agency players) such as Fannie Mae and Freddie Mac.

Many mortgage originators, however, may not yet embrace the opportunities presented by non-agency loans, or private-label portfolio products. They may be shying away from these alternative loan products because of misconceptions.

Stable and sound

Non-QM loans sometimes are portrayed as a euphemism for subprime lending. Today’s non-agency products, however, do not equate to the industry’s infamous subprime lending of the mid-2000s. Many of those subprime products that failed borrowers and lenders were poorly underwritten and, in many cases, relied on the expectation that home prices would continue to rise.

Non-agency loans in the current market are far more sound products than much of the prime lending that took place during the previous boom. QM rules may not apply to alternative lending products but these non-QM loans are still required to meet ability-to-repay rules.

Forget yesterday’s NINJA loans, or no-income, no-job, no-assets loans. Today, borrowers are required to provide substantial documentation and put significant skin in the game, ensuring that everyone has a stake in the performance of the loan.

In short, there’s no risk layering, just simple risk-based pricing. Even though non-agency products may not have the perceived safety features of a QM loan, today’s alternative lending products are solidly underwritten. The proof is in the results: Serious delinquencies to date for non-QM products stand at less than 2 percent. In addition, industry volume for these non-QM products is expected to double and may even triple in 2018, according to S&P Global Ratings.

Untapped market

Too many originators believe the borrower range and the market potential is limited for alternative lending products. This is understandable for those living and breathing QM loans for the past few years, but there is much in the way of untapped potential demand in non-agency lending.

In fact, with the refinance market essentially drained, and stiff competition for traditionally financed purchase loans, you could argue that the most growth in the next two years will come from the expanded non-agency lending. Right now, these loans constitute just a small fraction of the mortgage market. But that number is expected to rise dramatically now that rates have increased, and many creditworthy borrowers are unable to qualify for standard agency loans.

In total, 19 percent of the U.S. population has a FICO credit score between 550 to 650. A responsible alternative-loan solution for credit-impaired borrowers allows for loan-to-value ratios up to 90 percent, credit scores as low as 500 and loan amounts up to $2 million (however, not simultaneously).

That credit profile (a relatively low downpayment and less-than-perfect credit) represents a vast underserved market of borrowers that has earned an opportunity for homeownership. With no end in sight to the challenges borrowers face in many states, and with millennial buyers now entering the market in large numbers, offering alternative financing is a viable and necessary way to meet the pent-up demand.

The right partner

Another misconception is that there are not enough non-agency investors right now. True, the industry is not flooded with options for alternative-lending specialists but finding the right partner doesn’t have to be challenging. You just need to know what to look for. And, blindly choosing the lender with the largest volume is not the way to do it.

For a lending partner, you don’t want the team that is looking to score a quick buck, or one that just finished riding the refinance wave and is now trying to jump on the next bandwagon. You want a fundamentally sound lender with a proven track record, years of experience in the alternative-lending space and a comprehensive suite of products. 

Non-agency lending is not subprime. Today’s product is risk-based, carefully underwritten and has a proven track record.

Here are a few items to keep in mind in choosing a lender to work with. First, how much do they have at stake? Find out if the lender or investor keeps the loans in-house — in portfolio. If the lender isn’t interested in the long-term health of the borrower and the mortgage, it increases the incentive to abuse the products.

Then, analyze the lender’s underwriting practices. How the investor or lender determines the credit-risk profile and worthiness of purchase is crucial. Look at the company’s lending bottom line by examining how many defaults or foreclosures they process each year. That number tells you quite a bit about not only the risk profile of their borrowers, but their success in mitigating borrower challenges.

How experienced is the lender’s underwriting and compliance team? Are they well-trained and properly supported by executive leadership? Do they have access to a broad network of originators that have the pulse of the market and can anticipate changes in consumer demand and behavior?

Myth busting

In 2018, the Mortgage Bankers Association anticipates an overall decrease in mortgage originations, including a whopping 28.3 percent drop in refinances. Add to that increasing competition, consolidation, and pent-up consumer demand, and the time has come to meet the myths about alternative lending head-on.

Non-agency lending is not subprime. Today’s product is risk-based, carefully underwritten and has a proven track record.

Additionally, the alternative segment is about to take off in a big way, as investors are beginning to realize the opportunity in a market where excess liquidity can’t meet consumer demand because of the intended risk-based constraints of QM, which naturally result in some potential borrowers being unable to secure affordable financing. Finally, the right partners are out there, experts who have built the proper infrastructure, embrace compliance and have skin in the game by owning the loan.

•  •  •

Explore the growing world of expanded non-agency lending and see for yourself the potential that can fuel your future, regardless of rising interest rates and waning refinances.


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