In search of a competitive advantage, originators are leaping to alternative mortgages, loans that can benefit borrowers who may not qualify for more conventional financing. Even large financial institutions such as JPMorgan Chase and Goldman Sachs have created new divisions to follow in the steps of successful alternative-lender pacesetters.
One alternative option is the bank-statement loan. With the rise of entrepreneurship and the changing ways that workers receive pay, the bank-statement loan is a way to reach borrowers who may be left on the sideline by income-verification restrictions enacted after the housing crisis.
Bank-statement loans offer borrowers creative ways to verify income claimed on their 1003 mortgage-application form. Many creditworthy clients are unable to produce weekly or bi-weekly pay stubs required for conventional mortgages.
Originators who understand these mortgage trends and can accommodate these loan products into their sales strategy can expand their business. Still, mortgage professionals should understand the details, potential pitfalls and the reasons why industry skeptics are concerned.
Assessing risk
Let’s be clear: Vast differences exist between modern-day alternative mortgage options and the no-document loans of the 2000s. Those banking policies are viewed as archaic and do not resemble current alternative mortgages.
Today, alternative loans can help meet the financing needs of millions of credit-worthy borrowers. Bank-statement loans offer a solution for entrepreneurs, gig-economy workers, contractors and consultants who may not qualify otherwise. These potential borrowers are often flush with cash, and have solid income histories, conservative debt levels and housing stability.
Beauty stylists, bartenders, food-truck owners and fitness consultants are among the many types of applicants who lack traditional pay stubs that reflect their true income. By using bank statements as proof of income, underwriters can ascertain just how much these borrowers bring home each month. Lenders have referred to this as modern-day employment verification.
Originators who understand how alternative mortgages are underwritten may be able to better screen loan applicants and improve closing-rate percentages. Diving into the details can bring clarity on which qualifying standards are industry-specific or determined by each lender.
Credit scores are generally standardized across the industry, but income-verification practices are case by case. The increased risk of alternative loan products usually means that the borrower’s interest rate will be higher and will likely require a more stringent underwriting review.
Applicants will be required to produce one or two years of bank statements, with the latter option offering better rates and terms. Average monthly deposits are determined and utilized as the base monthly income for qualifying-debt ratios.
Originators can cast a wide net over a client pool because bank-statement loans are available for primary residences and investment properties. Bank-statement loan borrowers are granted a pay-stub exception when supplying proof of monthly income. That exception is given while still requiring qualified credit scores, debt ratios, loan-to-value ranges and employment history.
Bank statements in lieu of pay stubs require additional underwriting requests to further verify earned income. Underwriters could ask to see business licenses, income invoices and financial statements, for instance. Originators should avoid borrower shock by preparing them for an intense income-verification process if a bank-statement loan or alternative mortgage is selected.
Additional alternatives
There are other alternative mortgages for borrowers with hardships in one of the qualifying categories. Searching out lenders that specialize in specific hardship loans offers an originator more options when pitching a client.
A growing niche of wholesale lenders have made Federal Housing Administration (FHA) loans available to borrowers with credit scores as low as 580. The 620 minimum credit score needed for FHA has dropped, helping borrowers that qualify in every other category except credit.
Credit-score accommodation for a government-backed mortgage is a reminder that these offers could disappear if the market turns south. Two years of continuous employment is required for FHA loans, so it’s smart to get the employment verification early. Increasing exposure to more applicants because of lower credit scores is a great way to generate more loans.
The expansion of mortgage options for foreign nationals is another tool worthy of being in the origination portfolio. These mortgages are for people who have a financial presence in the U.S. through business or property ownership, but who aren’t a citizen.
Before these loans were available, foreign nationals were forced to pay cash for properties or search out a hard money lender. Wholesale lenders now see value in foreign nationals who have established a property or business in the U.S., and that streamlines the mortgage process for these buyers. It also qualifies them for rates and terms that are much better than hard money.
Potential pitfalls
Qualifying pitfalls occur with all loans, but mortgage professionals should pay extra attention when originating alternative loan products. One of the first potential pitfalls of bank-statement loans is the way each lender calculates monthly income from bank statements.
Some lenders dismiss transfers and payments from digital financial platforms such as Zelle, Square or PayPal. Other lenders will approve these payments pending an accompanying paper trail. The case-by-case nature of bank-statement loans is a reason to seek clarity on income calculations and guideline details before submitting the loan to the selected lender.
Another pitfall in originating bank-statement loans is how rental income is calculated for investment properties. Underwriters usually accept a duly executed lease agreement and deposit verifications for rentals. Underwriters take rental-income verification one step further by requiring a 1007 market-rent appraisal.
The market rent is established in the appraisal report by using comparable rental properties. Underwriting practices then call for a 15 percent to 25 percent reduction of the market rent, which varies from lender to lender, to account for ownership costs. Failing to factor in rental-income reductions could push final debt ratios above their acceptable limits, causing a loan request to be denied.
Increasing scrutiny
With the rising popularity of these creative financing tools comes fresh questions. News coverage appears wary of these products, often tying them to the worst loans before the recession. An article in The New York Times last year, for instance, suggested that lenders “are turning to more complicated loans, a remnant of the last housing boom, to bolster their business.”
A Wall Street Journal article points out that bank-statement loans gained traction in spring 2018. The piece outlines how these loans can be beneficial for buyers, but cites consumer advocates and industry experts who worry that these loans could lead to risks that contributed to the economic downturn of the 2000s.
Alternative lending is gaining traction because there’s an appreciating real estate market combined with a strong economy, according an analysis from investment bank Morgan Stanley. These loans are susceptible to falter if homes prices fall or the economy declines, according to the analysis.
As these solutions evolve, originators need to tread cautiously when receiving an alternative application. Relaxed lending standards is a highly contentious topic that demands all perspectives be heard.
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The rapid growth of alternatives has created new opportunities worthy of exploration. Originators who understand these alternative loan options can build a strategy to capture a competitive advantage.
