In 2023, mortgage brokers have often found themselves steering through a series of economic trends that have significantly impaired their book of business. The mortgage industry is grappling with the repercussions of higher interest rates, including fewer home sales and a substantial decline in demand for refinances.
“The beauty of non-QM is that whatever tricky situation a borrower might have, there is a likely solution.”
Because of these prevailing trends, mortgage brokers must explore strategies to diversify their loan products. One area to explore is the arena of nonqualified mortgages (non-QM). These are often quality loans that do not meet the strict guidelines to be purchased by the government-sponsored enterprises or the federal government.
This year has been marked by a significant amount of volatility in the U.S. banking sector. The failures of Silicon Valley Bank, Signature Bank and First Republic Bank created ripples throughout the financial landscape.
In the wake of the upheaval came proposed changes to Basel III capital requirements for major banks, with regulators aiming to finalize the rules by 2025 and fully phase them in by 2028. (Basel III is an internationally recognized set of regulations developed by the Basel Committee on Banking Supervision in response to the financial crisis of the late 2000s.)
“Industry experts, banking trade groups and regulators concur that the proposed rules are poised to impede bank lending capabilities, propelling consumers toward nonbank alternatives.”
Industry experts, banking trade groups and regulators concur that the proposed rules are poised to impede bank lending capabilities, propelling consumers toward nonbank alternatives. Despite the extended timeline for compliance, banks are already experiencing a sense of urgency to align with the new rules ahead of the deadlines. This stance has led to a tightening of credit boxes, with anticipations of further constrictions in lending standards.
For example, banks reported having tightened lending standards for all categories of residential mortgages during second-quarter 2023, according to a Federal Reserve survey of senior loan officers. This scenario represents a strategic opportunity for mortgage brokers to capture the market share of borrowers turned down by banks and redirect that business toward nonbank lenders.
In the face of the banking crisis, mortgage brokers can offer non-QM loans to fill the void created by recent restrictions. According to the Fed survey, a significant portion of banks reported having tightened standards on non-QM jumbo loans and, to a lesser extent, non-QM loans that meet conforming loan limits.
For originators grappling with reduced loan volumes, non-QM products emerge as a lucrative revenue channel and offer a plethora of options that cater to diverse borrower needs. Three non-QM products, in particular, are witnessing a surge in demand.
The first is the debt-service-coverage ratio (DSCR) loan for investors. More than 70% of small rental properties (one to four units) are owned by individuals, and nearly all of them are managed by the same people, who are defined as mom-and-pop landlords, according to the U.S. Census Bureau. Mortgage brokers can fill the needs of this target market by offering DSCR loans, which focus on the property’s cash flow rather than the borrower’s income.
Self-employed individuals have a persistent need for creative loan solutions, and there are now about 16.5 million self-employed people in the U.S. Instead of tax returns, non-QM loans offer these borrowers alternative ways to show income, such as bank statements or profit-and-loss statements.
Non-QM lending adeptly caters to foreign nationals who inspire to invest in U.S. rental properties or vacation homes. By contrast, many banks (even before the recent banking crisis) have traditionally shied away from mortgages to international investors. There is plenty of opportunity here for mortgage brokers, with the dollar volume of U.S. residential real estate purchases by foreign buyers topping $53 billion in the year ending this past March, according to the National Association of Realtors.
The beauty of non-QM is that whatever tricky situation a borrower might have, there is a likely solution. These specialty lenders are typically known for allowing higher debt-to-income ratios (50% to 55%) and lower credit scores (low 600s or high 500s). There are powerful options afforded by non-QM for all sorts of scenarios.
For instance, loan approval for a condominium is more difficult than it is for a single-family home, especially if the condo is nonwarrantable (does not satisfy the lending criteria of Fannie Mae and Freddie Mac). Non-QM lenders specialize in lending on nonwarrantable units, whether the issue concerns construction defect litigation or lack of adequate budget reserves by the condo association.
A narrow subset of DSCR lending caters specifically to short-term rental investments such as Airbnb and condotel properties. The non-QM lenders that offer these loans have flexible guidelines geared toward the calculation of short-term rental income.
As the recent Fed survey indicated, one area that banks cut back on the most this year is non-QM jumbo loans (those sized above $726,200 for a single-family residence in most areas of the country). With banks turning away applications for large loan amounts, mortgage brokers can step in to save the day. For example, there are non-QM lenders that offer “super jumbo” loans from $3 million to $30 million.
While the demand for rate-and-term refinances has taken a nosedive, opportunity remains for brokers to originate cash-out loans, especially since non-QM lenders allow generous amounts of cash back at the closing table. There are even non-QM, no-ratio loans for owner-occupied properties. This super niche product does not verify income or employment, as long as the borrower has a strong credit score and isn’t seeking a particularly high loan-to-value ratio.
By seizing the opportunities presented by the banking crisis and the tightening of lending standards, brokers can use non-QM products to continue providing value, flexibility and diversity in their mortgage offerings. This can allow brokers to serve a broader spectrum of clients.
As mortgage brokers venture into the diverse landscape of non-QM lending, it’s imperative to do so wisely. First, partner with reputable non-QM lenders. Meticulously research these potential partners before signing up with them.
The market turbulence of 2022 resulted in several non-QM lenders scaling back or ceasing their operations. More recently, some non-QM lenders have stopped offering certain niche products like the owner-occupied no-ratio loan, since it requires the lender to hold a special certification from the Community Development Financial Institutions Fund. These trends emphasize the importance of aligning with solid and reputable non-QM lenders.
Cultivate relationships with bankers, Realtors, accountants, attorneys and financial planners. Now more than ever, bankers are turning down their client’s mortgage requests. These clients would appreciate a referral to a quality mortgage broker. Engage in lunch-and-learns, particularly with Realtors. You’ll not only garner referrals to their clients but also cater to the agent’s investment property and self-employed lending needs.
Lastly, invest time to attend training workshops and acquire in-depth knowledge of each non-QM product. Establish a rapport with a proficient account executive and become well versed in the nuances of each product. This will allow a broker to pivot from selling rates (which are currently unappealing) to selling solutions.
Mortgage brokers are strategically positioned to leverage the opportunities arising from an evolving financial ecosystem. By embracing nonbank lenders and diversifying their portfolios with non-QM lending options, brokers can address the diverse needs of borrowers and establish a book of business that’s resilient to any economic or banking uncertainties. ●