As refinances start to taper off after years of historically low interest rates, mortgage originators should consider expanding their business in new directions. After accounting for more than 50% of all loan originations in every month of 2020, refinances shot up to a whopping 68% of loans closed this past February, according to ICE Mortgage Technology’s Origination Insight Report.
By June 2021, this share had dropped to 48%, marking the first time it had dipped below 50% since December 2019. And this trend is likely to continue as the refinance market slows, so mortgage originators should explore new areas to keep their loan pipelines full. Nonqualified mortgages (non-QM) may be the right market opportunity to emphasize. Non-QM loans are often quality loans that simply fall short of meeting the strict qualified mortgage standards set for loans that are backed or purchased by government agencies or the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.
Credit availability continues to be an issue for borrowers looking to purchase homes. According to the credit availability index from the Urban Institute’s Housing Finance Policy Center, mortgage credit availability was 5.1% in first-quarter 2021. Although this figure represents an increase from the historic low of less than 5% seen in third-quarter 2020, it’s still remarkably low by historical standards.
For example, from 2001 to 2003 (prior to the housing crisis), the standard credit availability for the U.S. mortgage market was 12.5%. This means that today’s borrowers who have anything less than pristine credit and perfect profiles are struggling to get mortgages, regardless of whether they are objectively creditworthy.
Part of the issue is the qualified mortgage rule. The criteria for a qualified mortgage are set by the Consumer Financial Protection Bureau (CFPB). Currently, the qualified mortgage rule requires loans to meet ability-to-repay guidelines and to be fully amortizing loans with terms no longer than 30 years.
In addition, the sum of points and fees cannot exceed 3% of the loan amount (except for loans of less than $100,000), and the borrower’s monthly debt-to-income (DTI) ratio cannot exceed 43%. Currently, there also is an exception for loans eligible for sale to Fannie Mae or Freddie Mac (known as the GSE patch). The CFPB is considering changing the DTI requirement to a price-based cut-off, but the implementation of this rule has been postponed until Oct. 1, 2022, in consideration of the effects of the COVID-19 pandemic.
Although the goal of the QM rule is to prevent the high-risk and predatory lending that contributed to the housing crisis, it inadvertently makes it more difficult for creditworthy borrowers to obtain the financing they need. Non-QM borrowers include self-employed and gig-economy workers, foreign nationals and those with individual taxpayer identification numbers, as well as investors and others who own multiple properties.
Conventional loans made up 78% of all originations this past June. Federal Housing Administration loans accounted for 11% and loans from the U.S. Department of Veterans Affairs were an additional 7%, leaving only 3% as “other,” according to ICE Mortgage Technology. This leaves just a tiny window for borrowers with alternative documentation or other issues.
The profile for all closed loans this past June tells a significant story: The average FICO score was 743, with a loan-to-value ratio of 74 and a DTI of 24/36 (front half, back half), according to the ICE Mortgage Technology report. These numbers have held remarkably steady for years.
According to credit bureau Experian, however, the average FICO score in the U.S. was 711 in 2020. Although this number is historically high, it still leaves many borrowers behind. Non-QM lending can help borrowers who have credit scores that are good but not perfect, as well as borrowers with recent credit events that caused a more significant dip in their score.
On many levels, credit scores don’t tell the whole story. Other issues can lead to borrowers being ineligible for a qualified mortgage — starting with employment. The prevalence of the gig economy, coupled with the turbulence caused by the pandemic, means that many workers with inconsistent incomes are facing difficulties in securing a mortgage regardless of their overall creditworthiness.
These borrowers often need alternative or limited documentation, as well as a lender capable of doing manual underwriting to look at their complete credit picture. Investors and owners of multiple properties are another group in need of non-QM lending as their DTIs often don’t reflect their actual financial situation. These borrowers often need loans with qualifications based on demonstrated cash flow.
It’s important, however, to distinguish non-QM from less secure loan types. These include no doc (no income verification documentation); NINA (no income, no assets); and the infamous NINJA (no income, no job, no assets), which helped to fuel the 2008 financial crisis.
Mortgage originators who want to explore this niche and find non-QM financing for their clients will need to do some research to find the right lenders for this business. One of the most critical aspects to consider is the amount of experience a lender has in originating non-QM loans.
Although more lenders are starting to dip their toes in the non-QM waters, inexperience can lead to rookie mistakes and even sudden freezes in non-QM lending activities, leaving borrowers in limbo. Originators should identify lenders with a dedicated non-QM team or department that have been operating successfully in the field for years.
Another important aspect to consider is underwriting, as this makes or breaks loan deals every day. Does the lender rely on automated underwriting? Although this can mean quicker turn times, it doesn’t work for non-QM loans. Manual underwriting with a dedicated and experienced underwriting department is critical, particularly for borrowers with any credit issues or lower credit scores. Manual underwriting can lead to other issues, depending on how the lender is structured.
Does the lender require investor approval? Research how the lender gets its funding and how decisions are made. Some smaller lenders must run funding requests past their investors. This is particularly important if your borrower may need some sort of exception. Having to seek investor approval for any loan that doesn’t fit their guidelines can cause serious delays in funding.
Although non-QM loans in general have longer turn times than conventional lending, that’s not an excuse for lenders to take their time in processing loan applications. Speed (coupled with accuracy and compliance) is vital in the mortgage industry. Get the data on the average turnaround time for any lender you’re considering partnering with. How long from application to close? How long until decisions are made on exceptions? These answers will be critical for you and your borrowers as they try to purchase or refinance a home.
Finally, research the programs and pricing offered by non-QM lenders. Are the programs flexible and responsive to the market? Does the lender offer a variety of products and services to meet your borrowers’ needs? These considerations will help any originator find a reliable lending partner in the non-QM market.
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As the market continues to shift away from refinances, mortgage originators need to expand their business in new directions, and non-QM loans are a growing niche. There are many creditworthy borrowers whose credit profiles don’t match up with traditional qualified mortgages, from the self-employed to investors with multiple properties.
These borrowers may find the financing they need in non-QM lending. Finding and partnering with an experienced non-QM lender is critical in this arena, as experienced lenders will have the underwriting staff and quick turnaround times necessary for success. ●