This piece originally appeared in the May 2022 edition of MReport magazine, online now.
Location is widely recognized to be of critical importance in real estate. Similarly, flexibility may be just as critical to the mortgage industry. However, finding that flexibility has been difficult for many years, as rigid loan guidelines and regulations have dominated originations, curtailing who is considered a “qualified” borrower and creating demand for loan products that can serve those borrowers who fall outside these parameters. Non-QM lending is a growing niche, and one that 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
Mortgage credit availability has remained low since the housing crisis in 2007. In addition to the regulations put in place to protect consumers, many lenders have been extremely risk-averse and have stuck to qualified mortgage originations as defined by the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac. This has left a significant percentage of the population without access to credit, despite other indicators of being creditworthy.
According to the Housing Finance Policy Center’s Credit Availability Index (HCAI), mortgage credit availability was 5.2% in Q3 2021; it stood at the same mark in Q2 2021. Although this is still historically low, it was an improvement over the record low of just below 5.0% seen in Q3 2020, reflecting the effects of the COVID-19 pandemic. However, from 2001-2003, prior to the housing crisis, the credit availability standard for the mortgage market was 12.5%. Borrowers with less-than-perfect credit or with unusual documentation or circumstances are now largely being left out of the mortgage market.
At the heart of the issue is the Qualified Mortgage Rule itself, as well as many lenders’ unwillingness to originate loans outside of those 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 backed or purchased by government loan programs or by the GSEs. These criteria currently include meeting the ability-to-repay rule, and loans must be fully amortizing 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 under $100,000), and the borrower’s monthly debt-to-income (DTI) ratio cannot be greater than 43%.
These rules were put in place after one of the worst financial crises in history, in order to prevent a repeat of the high-risk lending that caused the crisis. Despite good intentions, these regulations have created a set of borrowers that are left out of the housing market, despite being creditworthy. According to the ICE Mortgage Technology report, conventional loans continue to dominate, starting 2021 off with 84% of the market, although that dipped to 78% by December.
Federal Housing Administration loans made up 12% of originations in December 2021, while U.S. Department of Veterans Affairs made up 6%, leaving just 4% for other loan types. For borrowers who don’t fit into the 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 how wide-ranging those who fall into the category can be, from the self-employed to investors or from foreign nationals to gig economy workers. There is often the misconception that non-QM borrowers have low or bad credit. However, although some non-QM borrowers may have credit issues, many have high credit scores and are otherwise very qualified borrowers but need to use alternate documentation or a different way to calculate their income for qualification.
Certainly, one of the largest types of non-QM borrower is the self-employed or small-business owner. According to the Bureau of Labor Statistics, roughly 9.98 million Americans were self-employed in February 2022. Even more are looking to this avenue for better work-life balance, flexibility, and fulfillment. According to the FreshBooks 2021 Annual Self-Employment Report, 95% of the surveyed self-employed Americans intend to stay that way, and 40% of the traditionally employed consider it at least somewhat likely that they will work for themselves in the next two years (and that number goes up even higher for those under 35). Although self-employment took a hit during the pandemic, those numbers have largely recovered, and are increasing. In fact, analysis of current trends from QuickBooks projects a record-high of 5.6 million new business starts this year. Add on top of that the number of people in the United States engaged with the “gig” economy (which includes everything from long-term contract work to smaller “gigs” like Uber, Instacart, and others), and you have a significant portion of the population that doesn’t have traditional W-2s to demonstrate creditworthiness.
Another significant segment of the market is investors—particularly first-time 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’s no one easy profile to showcase, they will frequently need a different way to calculate their income for qualification, like bank statements or other alternative documentation.
But for many lenders, non-QM borrowers have very good credit profiles: average FICO scores from 720 to 740 and average loan-to-value ratios (LTVs) at 70% or lower.
But how do mortgage originators find a lender to meet the needs of these creditworthy borrowers?
Finding the Right Lender
Step one for meeting the needs of any non-QM borrower is simply finding a lender that offers non-QM products; and this, like nearly everything else, took a hit during the pandemic. However, as the market recovers and grows, more and more lenders are stepping into the space, and originators will need to seek out 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 dedicated department for these loans? Finding answers to these questions will require a bit of research, but lenders’ websites should offer insight into what they can provide for non-QM borrowers. Also consider: How much support and help do they offer originators and consumers with dealing with the demands of these loan applications? For mortgage originators, a lender that has dedicated support staff to helping structure these loans will be critical, especially if the originator is relatively new to the non-QM sphere.
Next, consider the underwriting offered. Is it all automated? Manual? Some combination of the two? With non-QM loans, exceptions are frequently the rule, so the ability to offer your clients manual underwriting, as well as the possibility of exceptions to guidelines and overlays, may mean the difference between successfully closing a loan or leaving 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 offered it? What kind of staff are dedicated to this area?
Also consider where the backing is coming from; research how the lender is funded and how decisions are made. Is the lender able to make decisions on exceptions or will they have to consult investors or other interested parties? This is particularly important for smaller lenders that may need to run loans past their investors, as this can affect turn times and if the loan will close with exceptions.
Ask: What percentage of their closed loans include exceptions? Answers to these questions will provide valuable insight into the lender and whether they will suit the needs of your borrower and your business.
Next, consider the products the lender offers. Do they have just one non-QM product or a full suite to meet a variety of needs? Do the products change as the market shifts? Are they flexible? As any two non-QM borrowers are rarely the same, it’s important to partner with a lender that offers a full range of products—not only to better meet the needs of borrowers, but to make a better partner for originators to go to with the full range of their clientele. 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 the employment market continue to shift, originators and lenders must shift to accommodate both.
Although conventional lending is still the largest segment of originations, originators should consider adding non-QM borrowers to their business. These borrowers are often objectively creditworthy, but simply require a bit more analysis of their financial situation than simply filling in boxes in an automated system. As more and more entrepreneurial Americans become self-employed or find success in the gig economy, the demand for mortgages to meet their needs will grow. Seeking out and partnering with lenders experienced in the non-QM sphere will mean more closed loans and more satisfied borrowers.