Riding the Verification Waves in a QM and Non-QM Sea

Qualified Mortgages Provide a Safe Harbor

Since January 10, 2014, mortgage loans must meet specific requirements in order to be considered Qualified Mortgages (QMs), and thus, be eligible for sale to the GSEs. By meeting QM standards, lenders move from the risky seas outside the breakwater into a safe harbor, receiving a level of legal protection against borrowers who default and then claim that the lender should have known the borrower couldn't repay the loan. Qualified Mortgage requirements include:

• Loan term cannot exceed 30 years
• Points and fees must be less than or equal to 3 percent of the loan amount; a higher percentage is allowed for loans under $100,000
• Loan cannot contain risky features, such as negative amortization, interest-only, or balloon payments
• Consumer debt-to-income ratio cannot exceed 43 percent
• The institution must under-write the loan taking into account the monthly payment for mortgage-related obligations. In addition, the monthly payment will be calculated using the maximum interest rate that may apply during the first five years.
• The consumer's income, assets, and debts have been verified in accordance with Appendix Q of the ATR/QM rule

When calculating debt-to-in-come ratio, lenders must be careful to include all required costs, such as homeowners and flood insurance, to ensure the later addition of these expenses don't push the ratio over 43 percent.

A High Tide of Income/Employment Verifications

The Appendix Q amendment to the ATR/QM rule sets forth the rules for how lenders should review a borrower's employment history, income, and debt-to-income ratio. Appendix Q requires verification of employment for the most recent two years, with explanation for any gaps longer than one month.

In order to meet the Appendix Q requirements, many lenders are turning to national databases like The Work Number, a solution offered through Equifax Workforce Solutions, to confirm employment records. The Work Number database contains more than 58 million current employment records contributed by more than 3,700 employers nationwide, making it the largest collection of payroll records contributed directly from employ-ers. This data is updated every payroll cycle, ensuring the most up-to-date information possible.

For those consumers who are not listed in a national database like The Work Number, manual verifications can be ordered from different sources. It is important to make sure that the supplier of the manual verification uses an auditable process in case the loan defaults.

Income can be verified by ordering a Tax Return Verification (IRS form 4506-T), which confirms both income and Social Security Number. TRVs can be easily ordered through online platforms provided by various mortgage services providers, and generally provide the needed validation within 24-48 hours.

Determining the debt-to-income ratio is generally straightforward, unless the applicant takes on new debt right before closing. Research shows that 22 percent of new debt is taken on by applicants in the 10 days before a home loan closes. Lenders can use Undisclosed Debt Verifications (UDVs) from all three bureaus to uncover new debt before it derails closing—or worse, delivers a costly buyback when the loan is validated by Fannie or Freddie and found to be out of compliance. UDVs show exactly what has been reported to the credit bureaus—new tradelines, inquiries, secondary reissues, bankruptcies, judgments, liens, collections, late payments (30-60-90-120 days), and even recent high utilization on existing bank card and revolving tradelines. Not every mortgage services provider offers UDVs from all three bureaus, so it is definitely something to verify before moving forward.

Navigate the Uncharted Waters of Non-QM Loans

There are many loans that don't fit Qualified Mortgage requirements. When executed properly, with complete documentation of income, assets, debt, and employment, non-QM loans may offer significant opportunity for lenders to make profitable, low-risk loans.

Non-QM loans often involve wealthy borrowers, self-employed business owners, doctors just beginning their careers, or even those with slightly blemished credit. Many people in these situations are considered reasonable risks even though their circumstances prevent them from meeting ability-to-repay rules.

According to the Consumer Financial Protection Bureau, as long as the lender makes a reasonable, good-faith determination that the consumer is able to repay the loan based on common underwriting factors, the lender can originate any non-QM mort-gage. The key is making sure the loan is going to perform for the long haul—and the way to do that is performing due diligence using third-party vendors.

Unfortunately, if the lender is using multiple vendors, vetting each one can be an extremely time-consuming process. Many lenders find that getting all their verifications from one vendor increases their productivity and decreases their stress level. In many cases, using one vendor means that the lender receives the applicant data at the same time as its brokers, which eliminates the possibility of any data manipulation.

All this is critically important because non-QM loans do not provide a safe harbor against borrower suits, nor is there a secondary market on which non-QM loans can be sold—at least, not yet. Because non-QM loans must be held in the lender's internal portfolio, verification must be as thorough as it is for QM loans in order to protect the lender.

Despite the higher risk, many lenders are planning to offer non-QM loans. According to the 2014 21st annual ABA Real Estate Lending Survey Report, more than one-third of bankers now plan to make non-QM loans in targeted markets or products.

Sailing the Verification Wave to Success

The decision whether to originate only QM loans or to move into the non-QM market is one that each lender will have to face as they set out on this new, uncharted mortgage ocean. What is your comfort level? Would you rather be able to see the shore, or do you want to explore what's over the horizon? There's no right or wrong answer—just what's right for you. But whether you choose QM, non-QM, or both, one fact remains the same—the right verifications partner can smooth the choppy waters so you can confidently cruise forward.

Greg Holmes is national director of sales and marketing at Credit Plus Inc., a third-party verifications company serving the mortgage industry. He can be reached at [email protected].