Editor’s note: This piece originally appeared in the May edition of MReport.
An industry veteran with more than 30 years’ experience, Jon Gerretsen focuses on operations, customer relationships, and risk management as President of Trelix. Prior to joining Trelix, Gerretsen spent eight years with NYCB Mortgage company as Director of Residential Mortgage Operations. He recently spoke with MReport about the challenges faced by lenders in the non-QM market and some of the best practices they must bring to the table to succeed in this segment.
How are non-QM loans different from the subprime loans of the past?
The mortgage loans crisis that occurred prior to 2008 was due to what would be considered loose underwriting standards. Most of those loans were products that required no verification—they were no income, no asset products. The market also had mortgage loans that technically weren't subprime.
All those products were introduced into the market to expand homeownership. During the crisis, the true subprime loans, those that were underwritten to subprime standards, weren't the ones that experienced the tremendous defaults. They were underwritten correctly because they were
looked at from the individual level. It's a bit of a broad brush to say that all loans during that time were subprime. Non-income verification products were the ones that caused most of the issues, and non-QM loans are not that type of product, with the key difference between the two being that the products that don't come under qualified mortgage (QM) are underwritten manually. These are non-QM products. Before 2008, lenders could make
independent decisions on QM products, so that if the loan-to value was 50 percent, there might not even be a review of previous income. For today’s QM products, federal regulations demand that each component of the file should stand on its own merit. As a result, not only does collateral have to be strong, but credit must be strong, and the debt-to-income ratio must be 43 percent or below. All these finance-specific criteria must be met independently. In a non-QM product today, some of these aspects can’t be reviewed independently. For example, if a self-employed borrower has been in business for two years and provides bank statements that reach a certain threshold, he or she might qualify for a non-QM loan. Thus, non-QM loans bring in compensating factors to QM where other characteristics of the borrower or the property could help support areas that may not be meeting the stated level of acceptance in QM.
What are some of the challenges faced by lenders in the non-QM market?
Lenders looking at non-QM loans face two key challenges today. First is the slow adoption of these products. Investors are still not jumping back in as they remain concerned about the certainty of selling these assets. Everyone realizes that the growth will take place. It's the uncertainty related to this
growth that’s keeping investors away. While there are a couple of investors who are moving into this market, they’re doing so with strict guidelines and disciplined practices. There's a lot of due diligence that's performed before investors will purchase non-QM these days.
Secondly, the separate process of manually underwriting non-QM loans is proving to be a difficult task for many lenders. Everybody has automated underwriting. As a result, the process of manual underwriting that’s required for nonQM loans does not fit the current infrastructure of most lenders. It's more difficult because lenders are going back to doing things the old-fashioned way, and there's a shortage in terms of processes and
resources for them.
What are some of the best practices that underwriters must follow to ensure the quality of these loans?
Manual underwriting is the best practice that lenders can adopt for these loans. In non-QM loans, because one area of the loan is significantly stronger than others, you must underwrite all the different facets of the loan. It's a skill that underwriters possess. Also, because there are limited investors, lenders want to ensure that the overlays or the product qualifications that are available for investor purchase are all met so there’s rigidity of the discipline in place even though a loan may be considered non-QM.
How can lenders benefit from non-QM loans despite these challenges?
NonQM loans expand the number of potential borrowers for lenders. They open the market to an underserved demographic who, from 2014 on, after QM was initiated, were not able to purchase homes anymore because they did not meet the criteria of ability to repay or did not meet certain pieces of QM integration.
What is your outlook for nonQM in 2019 from an investor’s and a lender’s perspective?
As the industry starts to become more comfortable with the fact that it's not going back to where we were a decade ago, and that non-QM loans are helping to expand responsible homeownership, this product will grow.