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   ARTICLE   |   From Scotsman Guide Residential Edition   |   September 2018

Alternative Loans Can Grow Your Business

Originators can tap into a bigger pool of borrowers by going beyond conventional lending

As refinances decrease because of rising interest rates, and the competition for borrowers who qualify for conventional loans becomes more fierce, mortgage originators must find new ways to expand their business. r_2018-09_brousseau_spot

The average 30-year mortgage rate was up to 4.79 percent this past April, compared to just 4.41 percent in April 2017, according to mortgage software company Ellie Mae. Although conventional lending continues to dominate the mortgage market, accounting for 66 percent of all loans originated in April, originators who are navigating the present and looking to the future should prepare to expand their client base beyond borrowers with high credit scores that easily fit in the conventional box.

The variety of alternative-lending products available today helps to ensure viable solutions exist for the millions of potential homebuyers waiting on the side-lines because of their less-than-perfect credit, self-employment and other life issues that can take conventional financing off the table. Although government loans are a fairly well-known source of nonconventional funding for mortgages, many lenders are now bringing additional proprietary-loan options to the table that can meet the needs of borrowers across the spectrum of loan amounts and credit profiles.

Having a variety of products available helps more borrowers become homeowners. It also helps mortgage originators broaden their client base and subsequently increase the volume of loans they successfully close.

Government loans

When a borrower doesn’t fit the criteria for conventional lending, often the nextplace a mortgage originator will turn is to government-backed loan products from the Federal Housing Administration (FHA), the U.S. Department of Veterans Affairs (VA) or the U.S. Department of Agriculture (USDA). These often offer lower downpayment minimums and lower credit-score thresholds as well.

The FHA will insure mortgages for borrowers with credit scores as low as 500 if there is a 10 percent down-payment. For borrowers with credit scores of 580 or higher, the FHA allows for downpayments as low as 3.5 percent. The problem for many borrowers, however, is that even though these products are avail-able, some lenders do not actually lend to customers who fall into those lower credit categories. The average FICO score for FHA purchase loans in April 2018 was 676, with a loan-to-value (LTV) ratio of 95 percent, according to Ellie Mae. Of all FHA loans closed this past April, only 5.96 percent went to borrowers with credit scores below 600.

Many borrowers today are creditworthy potential homeowners who just can’t find the right financing.

VA loans also offer extremely favorable terms for borrowers, but are only available to eligible U.S. service members, veterans, some reservists and National Guard members and surviving spouses of military members. Although this limits the borrower pool, those eligible for these loans can enjoy no-downpayment loans with no mortgage insurance. The VA also does not set a minimum credit score, but like FHA loans, many lenders do. The average FICO score for closed VA purchase loans this past April was 707, with an LTV of 98 percent, according to Ellie Mae.

USDA loans also offer the benefit of no-downpayment programs, but no military service is required. Often, people think because the programs are under the USDA umbrella, the loans are only for farms. That is not the case. The USDA Rural Development office provides loan programs for homes in qualified rural areas throughout the U.S.

Aimed at low- or moderate-income borrowers, the USDA offers two main programs for homebuyers. The Section 502 Direct Loan program is focused on low- and very-low-income applicants and provides payment assistance for qualified borrowers. The program has a zero-downpayment option. The Guaranteed Home Loan program is for moderate- or low-income borrowers to purchase or rehabilitate a home. Although neither program has credit-score minimums, many lenders will only issue loans to borrowers who meet their FICO-score requirements.

Mortgage professionals who want to start working with these loans or to increase the number of government loans they originate should learn the credit requirements of their lending partners, as well as seek additional partners that may be particularly experienced with these types of loans.

Nonprime loans

While government loans are an excellent alternative to conventional mortgages for many borrowers, the requirements to qualify for these loans and loan programs are very specific and eliminate many potential homeowners.

Despite what the particular numbers might indicate, these borrowers often would successfully sustain homeownership and present minimal risk to lenders. Since the Great Recession, many lenders have been incredibly risk averse, and mortgage credit has been tight. Borrowers with lower credit scores or higher debt-to-income ratios have been all but locked out of the market. Some lenders are now recognizing this segment of potential homebuyers, however, and have begun offering nonprime mortgage products that offer the flexibility to underwrite to the specific borrower, not just the raw numbers.

In 2017, 21.2 percent of the U.S. population had a credit score below 600, according to Experian’s State of Credit survey. Sixty-nine percent of all closed loans this past April had a FICO score of 700 or higher, according to Ellie Mae. This is leaving a huge swath of the market unaccounted for and represents significant opportunities for mortgage originators and lenders that can work within this space responsibly.

Some lenders are responding to this rising demand with loan products that seek to balance risk in their underwriting. With nonprime mortgage products, manual underwriting is key to responsible lending, and originators should look for lenders that not only look at each borrower as an individual, but also lenders that back their underwriting with strong, high-touch servicing.

If a borrower is looking for a mortgage but has a low credit score, for instance, lenders working in the nonprime space will likely balance that risk by requiring a higher downpayment and more cash reserves. Some nonprime products allow credit scores as low as 500.

By looking at the borrower closely through manual underwriting, lenders and originators are able to distinguish between individuals who make consistently late payments (creating a lower credit score), and those who had one bad credit event — and subsequently have a lower credit score. Nonprime loans also can be an option for borrowers who are not conventionally employed, such as those who own their own small business or are self-employed as freelancers or contractors. Responsible lenders in this sphere will want full documentation, so prepare borrowers for this reality.

Nonprime products can be for either purchase or refinance, and credit and downpayment requirements will vary from lender to lender — and likely from borrower to borrower, as well, if manual underwriting is the norm. Originators should be aware of nonprime products as they come to market and be prepared to help their clients secure the mortgage they may have previously thought was unattainable.

Jumbo loans

Another nonconventional mortgage product is the jumbo loan. Although borrowers who need jumbo mortgages often have strong credit profiles, they still are not considered conventional borrowers. A jumbo loan is any loan that exceeds the maximum conforming-loan limits set by the Federal Housing Finance Agency (FHFA) for Fannie Mae and Freddie Mac.

For this year, the limit is $453,100 for most of the U.S. and $679,650 for certain high-cost areas, such as Alaska and Hawaii. Although the loans themselves fall outside the conventional-lending umbrella, often jumbo borrowers would fit into conventional-lending criteria except for the high cost of the homes they are purchasing. Because they fall outside of conventional lending standards, jumbo loans often have higher interest rates, require larger downpayments, and entail stricter underwriting rules.

These loans can have 15- or 30-year terms and can be fixed or adjustable rate. Credit-profile and downpayment requirements vary by lender and loan amount. Originators should look for lending partners that offer a variety of loan products for their jumbo customers so they can ensure that clients get the best mortgage for their particular financial situation.

•  •  •

Although conventional lending has a large market share, mortgage originators need to look for alternatives if they want to increase their business and widen their customer base. Many borrowers today are creditworthy potential homeowners who just can’t find the right financing.

By educating themselves on all that is possible for borrowers today and partnering with lenders that offer a wide range of flexible mortgage products, mortgage professionals can help more clients become responsible homeowners and, in the process, close more loans.


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