Sub-prime loans are making a comeback, but don’t assume that they’re the same products as those that contributed to the financial meltdown of 2008 (and stop calling them sub-prime). After all, this isn’t the wild west of the mid-aughts, when borrowers who could not afford a mortgage were granted one. Most of the borrowers in this space today aren’t high-risk at all, as three industry experts explained in a recent WebCast hosted by Originators Connect.
“We believe it’s an exciting category in a mortgage industry that’s struggling a little bit right now,” said Tom Hutchens, senior vice president of sales and marketing at Angel Oak Mortgage Solutions, which has been pushing an education and awareness campaign about how originators can work non-QM loans into their offerings.
As the market has rebounded been rebuilt, a new category of borrower has emerged – or rather, a category of would-be borrower who has been left by the wayside: people who have been knocked out of the market by today’s very risk-averse standards.
“There are a lot of people who would like to get back into the housing market but have less than perfect credit record that shouldn’t make them not credit worthy, there should be a product and service that allows them to get back into home ownership or allows them to tap into the equity of their property in a responsible and sustainable way,” said Rick Sharga, executive vice president of Carrington Mortgage Holdings, LLC.
“We are trying to get as many people back into the game as possible, but we want to do it in a way that’s responsible, in a way that’s sustainable, and in a way that doesn’t repeat the same mistakes that the industry made in the early part of the decade of the 2000s.”
There are plenty of people – customers and originators alike – who are wary of the non-QM loan. The truth of the matter is, getting these non-prime (or non-QM, or near-prime) loans right is a balancing act, and by all accounts, the industry is in a much better place to get that balancing act right today than it was a decade ago.
“It’s a completely underserved market,” said Will Fisher, senior vice president of Citadel Servicing. “There are very deserving borrowers in the space, it can be done very well and responsibly, there are just certain rules that we have to adhere to. A lot of regulation from the government is to help keep things on the straight and narrow. Inside these rules, we can make these loans and they’re very good quality. They’re some of the highest quality, some of the best vintages we’ve seen in years . . . [but] there’s a lot of fear out there.”
There are a few differences in how these non-QM loans are done today versus how they were done in the past, and that should give you peace of mind. One of these things that’s changed is how invested everyone is in the loan itself. Hutchens said that borrowers are now required to provide down payments, where pre-crisis, when loans with 100% financing were rampant, “it was very easy for people to walk away because they had no skin in the game,” Hutchens said.
The increased amount of “skin in the game” isn’t just for borrowers and lenders, but for investors as well. Any issuers of non-QM securities are required to hold onto the loans for a minimum of five years.
Another difference, Sharga pointed out, is that the unwritten rules for commonsense underwriting were routinely ignored. There was a lot of risk layering, which means a borrower with a low FICO score – not necessarily a high risk on its own – was also given a loan with no down payment requirement on top of maybe having a 100%-110% LTV, on top of being unable to provide full documentation; in other words, it was risk upon risk upon risk. Today, that risk is offset, so while that same borrower may have a low FICO scare, for example, he would be required to make a higher down payment. There is a lot more manual underwriting of these loans, and the underwriter takes a deeper look at the whole picture of the borrower.
Originators can be reassured by the increased safeguards, and excited by the sheer number of potential borrowers in this category, in addition to the fact that there’s a lot less competition, as none of the major depository banks are doing non-QM loans.
“All of the loans that we’ve seen from the bigger players have either been strictly within the QM guidelines or they’ve been jumbo loans with high net worth individuals that are kept on portfolio,” Sharga said. “If you look at the overwhelming majority of loans being issued by the traditional players, most of them fall squarely within QM box because of regulatory risk, of compliance risk, reputation risk, litigation risk, you name it, they’re people who have opted out.”
Opting out means that there’s a lot of originators who are unable to add it to their product offering, which opens the door for anyone who’s able to reach these potential borrowers and close on their loans. It could be a great boost to existing business.
“This non QM space is so small relative to the pre-crisis size, but also relative to the mortgage market as a whole, there is so much opportunity right now with the current products, no one’s really rushing to expand guidelines and start doing crazy loans however you define that,” Hutchens said. “We’re in the right area. The guidelines, the products, the programs, they’re right. We just need to continue to educate the originators and the other participants in the real estate space so that they know these products and programs are available.”
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