This piece originally appeared in the February 2023 edition of MReport magazine, online now [1].
For more than a decade leading up to the pandemic, mortgage rates sat at a comfortable average [2] of about 4%—occasionally dipping to 3.31% at lower points, and very briefly reaching 5.21% as a high.
Nestled between the housing crisis of the early 2000s and residual effects of the real estate market craze of 2020, this sets a relatively tame stage for the exploration of non-qualified mortgages (non-QM). Cue the mortgage rate pandemic plunge and subsequent boom in the refinance market, and every lender operating in the non-QM sector was pushed to see just how well their program could stand the test of a very turbulent time. As a result, lenders continue to leave the non-QM space, and repercussions have caused mortgage brokers and originators some whiplash. But there are still creditworthy borrowers who need the flexibility of non-QM loans, and lenders able to meet those needs.
Addressing the Market
2022 marked the start of a slowdown in the housing market, which has only continued into the new year. According to statistics provided by Freddie Mac [3], rates just about doubled from 3.22% to 6.42% in just 12 months, with a few months reaching right above 7%. Refinances continue to account for less and less of loans originated, sitting at about 30% of all applications [4]. And according to a recent economic and mortgage market forecast produced by MBA Research & Economics, loan originations volume is expected to continue to decrease this year, although not as steeply as it did in in 2022 [5]. So, what’s the story here?
Keeping a pulse on the market is a smart move. Many brokers and borrowers felt the sting of the non-QM sector in recent years as lenders took a step back to refine their expertise. Even as lenders begin to re-enter the space, what’s still relevant is longevity. Can a lender go the distance? Because of the recent surge in mortgage rates and subsequent housing prices, working within non-QM can appear to be volatile. However, the market is beckoning some level of resilience and housing prices are beginning to soften.
As this continues, borrowers will take advantage.
Although this isn’t the time for a lender to have all their loan originations and liquidity in one basket, proper program recalibration set in motion back in 2020 should pave the way for opportunity—more specifically in the non-QM niche. Just as purchase and refinance origination volume is expected to rebound, non-QM has already started to see an increase in market share from its all-time low of 2% in 2020 [6]. Brokers erring on the side of caution when it comes to working with borrowers in need of a non-QM loan can find reassurance in the fact that stability still exists within the sector.
Identifying Stability in Non-QM
Since the introduction of non-QM loans, many lenders have expanded their program structure to capture borrowers outside qualified mortgage (QM) criteria set by the Consumer Financial Protection Bureau (CFPB). They’re assuming risk of a manually underwritten loan that qualifies a borrower who otherwise might not be approved based on conventional credit and ability-to-repay criteria. Manual underwriting has been around since well-before the induction of non-QM loans, and serves as an alternative to automated underwriting, which approves borrowers based on QM rules that help mitigate risk for the lender. True expertise in the non-QM niche means segmented dedication in both forms of underwriting, equipping a lender to play the long game more effectively.
However, stability in non-QM relies on more than a strong underwriting skill set. Brokers should also look at how responsive lenders are to the market. Pricing speculation is a dangerous game, and with the market moving as fast as it is going into 2023, being a price leader may not hold the strongest position as a lending partner.
Competitive pricing may seemingly have less of an edge because it’s not the cheapest, but it offers the advantage of more secured longevity.
The appeal in being priced out rests with the result that the lender will, in theory, be around “tomorrow,” instead of getting played by the market. Fall-out naturally becomes less likely, which means brokers and borrowers reap the benefits of a smooth process with less breaks in the chain. And right now, especially, history and credibility matter.
Operation within the niche sector dried up almost completely as market conditions placed constraints on liquidity. For some lenders operating specifically within the non-QM sector, these constraints forced their hand in immediate loan suspension and sometimes left minimal margins of reconciliation for brokers and borrowers in the process. It’s important for brokers to identify causation of any prior liquidity issues as a result of the market turn in recent years. Did they lose their takeout? Do they have a strong investor backing them? What, if any, did servicing assets look like? And on the other side of all this, how did these lenders honor their existing pipeline as a result?
Considering Commitment
Non-QM loans continue to bridge the gap between creditworthy homebuyers with qualifying criteria outside the QM rule box, and the ability to still obtain a mortgage. People who are self-employed, bring in nontraditional income, qualify from bank statements instead of W-2s, gig economy—these kinds of earners and borrowers. As lenders began evacuating the non-QM space a few years ago, some of the pipelines containing this subset of unique borrowers were left floating in limbo. Loans went unfunded, locks were not honored, correspondent purchases were ignored, and unfulfilled commitments left borrowers and brokers in limbo. Integrity sometimes took a backseat, and market approach was severely impacted by inherent risks that came with the turn of the market, especially if investor backing wavered.
Pricing to risk and strong guidelines can help create attractive exceptions. Additional solutions such as offering profit and loss (P&L) loans through a third-party help tilt the scale of loan flexibility even further.
Special program features, such as applying a waterfall on non-QM, to strategically sift through every loan option and exception, only further a lender’s ability to remain nimble amid market adversity. Even as volatility in the housing market continues to be fueled by a culmination of limited inventory, interest rates and inflationary pressures, the need is still there.
The value the wave of this influx offers to brokers, specifically, is that it places a spotlight on a lender’s ability to follow through on a commitment. The bigger picture here is taking these things and creating a confluence to form a single channel in the form of non-QM.
Going back to the importance of lending longevity, brokers should consider how lenders approach non-QM. This is where commitment to expertise can shine.
Again, going back to the need for teams dedicated to manual underwriting as a channel separate from conventional loan origination, allowing guidelines to serve as an enhanced viewpoint of the borrower themselves. These things combined can serve as a compass for brokers serving unique borrowers whose mortgage relies on the strength of truly viable non-QM lending options.