Will it prompt another subprime mortgage crisis?
The growing housing affordability issue, due to increasing mortgage rates and high home prices, has resulted in originators producing more affordability products, causing expected losses in non-qualified mortgages (non-QM) to rise, according to a new Fitch Ratings report.
Affordability products, such as over 40-year terms to maturity, interest-only periods, adjustable rates, and balloon payments, allow borrowers to qualify for loans and make monthly payments through longer terms to maturity or other features to satisfy the Ability to Repay (ATR) Rule. Although most loans in non-QM residential mortgage-backed securities (RMBS) transactions are 30-year fixed-rate loans, a growing volume of mortgages has affordability product features. Non-QM 30-year fixed-rate loans are typically 1-2% higher than prime 30-year fixed mortgage rates, which increased from the mid-3% range to over 7% in 2022, now hovering around 6.5%-7.0%.
While affordability products are similar to those seen in the 2008 financial crisis, Fitch Ratings believes that the resurgence of these products will not result in a “similar deterioration in performance,” as a number of safeguards are now in place to prevent a repeat of the implosion of the private label US RMBS market.
However, lenders are subject to more stringent lending and disclosure laws, including the ATR Rule and TRID. Fitch models higher stressed losses for affordability products and adjusts modeled losses based on the results of the third-party review (TPR) firms that conduct credit, compliance, valuation, and data integrity reviews on loans in new US RMBS transactions to ensure they are being underwritten to the originator’s guidelines, citing any exceptions they find.
The credit quality on a weighted average basis has declined in the past year as affordability has decreased, although the overall credit box for non-QM tightened in 1Q23 from 1Q20, with WA FICO increasing 20 points to 741 and DTI decreasing 2% to 34%.
Fitch reviewed eight Fitch-rated non-QM issuers and found that along with the higher volume of affordability products, weighted-average FICOs have declined and weighted-average CLTVs increased in non-QM RMBS transactions, reflecting a shift from refinancing to purchase activity and increasing average expected losses.
Moreover, the concentration of debt-service coverage ratio (DSCR) loans has also increased in issuer pools since January 2022, a loan product underwritten to the cash flow from rent payments rather than the borrower’s ability to repay. Fitch has seen originators targeting DSCR product borrowers at a higher rate to drive business, as the spike in interest rates has driven many potential home buyers to continue renting, leading to a booming rental market.
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