This piece originally appeared in the May 2022 edition of MReport magazine, online now.
Location is widely recognized as being critically important in real estate. Similarly, flexibility can be just as essential for the mortgage industry. However, finding this flexibility has been difficult for many years as rigid lending guidelines and regulations have dominated originations, narrowing who is considered a “qualified” borrower and creating demand for loan products that can serve borrowers who do not fall within these parameters. Non-QM loans are a growing niche, which can not only help originators grow their business, but also help borrowers who have been overlooked by conventional lenders. But why does the market need non-QM loans? Who are today’s non-QM borrowers? And what do they need from a lender?
Credit availability remains low
The availability of mortgage credit has remained low since the housing crisis in 2007. In addition to regulations put in place to protect consumers, many lenders have been extremely risk averse and have been content to provide qualified mortgages such as defined by the State Sponsored Enterprises (GSE), Fannie Mae and Freddie Mac. This left a significant percentage of the population without access to credit, despite other creditworthiness indicators.
According to the Housing Finance Policy Center’s Credit Availability Index (HCAI), the availability of mortgage credit was 5.2% in the third quarter of 2021; it was at the same level in Q2 2021. Although still historically low, this is an improvement from the record low of just under 5.0% seen in Q3 2020, reflecting the effects of the COVID-19 pandemic. However, from 2001 to 2003, before the housing crisis, the standard of credit availability for the mortgage market was 12.5%. Borrowers whose credit is less than perfect or who have unusual documents or circumstances are now largely excluded from the mortgage market.
At the heart of the problem is the qualified mortgage rule itself, as well as the reluctance of many lenders to lend outside of these narrow parameters. What is considered a “qualified” mortgage is determined by the Consumer Financial Protection Bureau (CFPB) as part of the criteria that must be met for a mortgage to be guaranteed or purchased by government loan programs or by GSE. These criteria currently include comply with the repayment capacity rule, and loans must be fully amortized with terms not exceeding 30 years. In addition, the sum of points and fees cannot exceed 3% of the loan amount (except for loans under $100,000), and the the borrower’s monthly debt-to-income ratio (DTI) cannot exceed 43%.
These rules were put in place after one of the worst financial crises in history, to prevent a repeat of the high-risk loans that caused the crisis. Despite good intentions, these regulations have created a set of borrowers who are excluded from the housing market, despite their creditworthiness. According to the ICE Mortgage Technology report, conventional loans continue to dominate, as of 2021 with 84% of the market, although this fell to 78% in December.
Federal Housing Administration loans accounted for 12% of originations in December 2021, while the US Department of Veterans Affairs accounted for 6%, leaving only 4% for other types of loans. For borrowers who do not meet qualified standards, this leaves little room to acquire the financing they need.
Who are non-QM borrowers?
Part of the difficulty with the non-QM borrower as a subset of the market is the diversity of those who fall into the category, from self-employed to investors or foreign nationals to gig economy workers. Non-QM borrowers are often mistakenly believed to have weak or bad credit. However, while some non-QM borrowers may have credit issues, many have high credit scores and are otherwise highly qualified borrowers, but must use other documents or another way of calculating their income for qualification. .
Certainly, one of the biggest types of non-QM borrowers is the self-employed or small business owner. According to the Bureau of Labor Statistics, about 9.98 million Americans were independent in February 2022. Even more are turning to this avenue for better work-life balance, flexibility, and fulfillment. According to the FreshBooks 2021 Annual Freelance Report, 95% of US freelancers surveyed intend to stay that way, and 40% of traditional employees consider it at least somewhat likely that they will work for themselves in the future. over the next two years. (and this number increases even more for those under 35). Although self-employment has been hit during the pandemic, these numbers have largely recovered and are growing. In reality, analysis of current trends in QuickBooks projects a record 5.6 million new businesses started this year. Add to that the number of people in the United States engaged in the “gig” economy (which includes everything from long-term contract work to small “gigs” like Uber, Instacart and the like), and you have a sizable slice. of the population that does not have a traditional W-2 to demonstrate its solvency.
Another important segment of the market is investors, especially new investors who may not have the business or credit history to qualify for a more conventional product. So what does a non-QM borrower look like? Although there is no easy profile to present, they will often need a different way of calculating their income for qualification, such as bank statements or other alternative documents.
But for many lenders, non-QM borrowers have very good credit profiles: average FICO scores of 720 to 740 and average loan-to-value (LTV) ratios of 70% or less.
But how do mortgage originators find a lender to meet the needs of these creditworthy borrowers?
Find the right lender
The first step in meeting the needs of any non-QM borrower is simply to find a lender that offers non-QM products; and that, like almost everything else, has taken a hit during the pandemic. However, as the market recovers and grows, more lenders are entering the space, and originators will need to research what differentiates one non-QM lender from another.
The first, and perhaps most critical, differentiator is experience.
How long has this lender been offering non-QM loans? Do they have a service dedicated to these loans? Finding answers to these questions will take a bit of research, but lenders’ websites should offer an overview of what they can offer non-QM borrowers. Also consider: What support and assistance do they offer originators and consumers to meet the demands of these loan applications? For mortgage originators, a lender that has dedicated support staff to help structure these loans will be essential, especially if the originator is relatively new to the non-QM sphere.
Next, consider the subscription offered. Is everything automated? Manual? A combination of the two? With non-QM loans, exceptions are often the rule, so the ability to offer your clients manual underwriting, along with the possibility of exceptions to guidelines and overlays, can be the difference between successfully closing a loan. or leave your borrower unsatisfied. If the lender offers manual underwriting, dig a little deeper. What kind of expertise do they have in manual underwriting? How long have they been offering it? What type of staff is dedicated to this area?
Also consider where the support is coming from; research how the lender is funded and how decisions are made. Is the lender in a position to make decisions on exceptions or will it need to consult with investors or other interested parties? This is especially important for smaller lenders who may need to provide loans to their investors, as it may affect turnaround times and whether the loan will close with exceptions.
Ask: What percentage of their closed loans include exceptions? The answers to these questions will provide valuable information about the lender and whether they will meet the needs of your borrower and your business.
Next, consider the products offered by the lender. Do they have a single non-QM product or a full suite to meet a variety of needs? Do the products change as the market evolves? Are they flexible? As two non-QM member borrowers are rarely the same, it is important to partner with a lender that offers a full range of products, not only to better meet borrowers’ needs, but also to become a better partner for borrowers with all of their customers. Non-QM lenders should offer a variety of products, from purchases to refinances and from primary residences to investment properties.
By asking these kinds of questions and researching the lenders available in the non-QM market today, originators will be able to find a lender that meets the needs of their borrowers.
As the mortgage market and job market continue to evolve, originators and lenders must evolve to accommodate both.
Although conventional loans are still the largest origination segment, originators should consider adding non-QM borrowers to their business. These borrowers are often objectively creditworthy, but simply require a little more analysis of their financial situation than just filling in boxes in an automated system. As more American entrepreneurs become self-employed or succeed in the gig economy, the demand for mortgages to meet their needs will increase. Finding and partnering with experienced lenders in the non-QM sphere will mean more loans closed and more satisfied borrowers.