Key provisions of the post-financial-crisis Dodd-Frank Act were designed to prevent another subprime mortgage crisis by making sure mortgage bankers carefully considered who they made loans to.
The qualified mortgage (QM) rule, which was implemented in 2010 as a part of the Dodd-Frank Act, opened up banks and other mortgage lenders to greater legal liabilities if they made loans to non-qualified borrowers. As a result, many of these institutions pulled back from the non-QM lending market, effectively hamstringing the U.S. housing market.
The Consumer Financial Protection Bureau (CFPB) eventually adopted a rule in 2014 providing banks and mortgage originators with limited liability protection in non-QM lending. The rule has clearly helped quell fears about lawsuits, buybacks and other damages, but lenders have remained hesitant to enter the non-QM market for the most part. Based on the American Bankers Association’s (ABA) 2016 Real Estate Lending Survey, only 14% of the typical bank’s mortgage loans originated in 2015 were non-QM.
In a recent article in GoRion, Sam Bourgi highlights industry sources that estimate the concerns surrounding non-QM loans could lead to as much as a 7% annual reduction in originations. Given the U.S. mortgage industry made $1.2 trillion in loans in 2015, that means more than $80 billion in loans did not get made.
Although the ABA survey results show a recent uptick in non-QM lending, note that 72% of survey respondents still anticipate that the CFPB’s new mortgage lending rules will lead to an overall reduction in credit availability.
Many mortgage industry analysts and a number of media pundits have recently stated they expect to see strong growth in the non-QM lending space over the next few years.
Although it has taken a solid two years to get over their worries, lenders are finally doing more than just dipping their toes into the market. In fact, the latest numbers show that non-QM mortgages already make up well over 10% of U.S. residential real estate lending today.
Also keep in mind that industry insiders suggest the non-QM segment of the residential loan market could continue to trend up to more than $2 trillion over the next four or five years.
Recent data from the ABA Real Estate Lending Survey also suggest that less than a quarter of lenders are only making QM loans, around half are limiting non-QM loans to targeted markets or have other restrictions in place, and around a quarter of lenders have no specific restrictions on issuing non-QM mortgages. The survey also shows that the most common reason for a mortgage loan to not meet QM standards was a high debt-to-income ratio, and the second most common reason for not qualifying per the CFPB standards was a lack of required documentation.
“While banks continue to grapple with the overwhelming amount of new regulation in the mortgage space, we’re pleased that the market has shown some resiliency and adjustment,” Robert Davis, ABA executive vice president, notes. “Despite regulatory and economic headwinds, community banks have proven to be strongly committed to first-time home buyers.”
More options for home buyers
Qualified mortgages are not allowed to include a number of features that are increasingly popular among modern home buyers. For example, QMs cannot have terms longer than 30 years. So, lenders that want to attract home buyers in ultra-expensive markets by offering financing with terms beyond 30 years (i.e., 40- or 50-year mortgages) must accept the additional risk of writing non-QM loans.
Also note that all income must be fully documented in a QM loan. This means any type of stated income on your mortgage application, even if it is only a small percentage of the total listed income, pretty much automatically means you are looking at a non-QM loan.
New models for lending to the underserved
The key to growth in the non-QM lending space over the next few years is innovative approaches to reach underserved demographics. Not surprisingly, lenders moved relatively quickly into jumbo loans to wealthy individuals that are non-QM strictly by virtue of their size, but there was not a lot of other non-QM lending until recently.
There are tens of thousands of potential mortgage borrowers out there who have solid incomes and present a low credit risk but still do not qualify for a mortgage based on the current relatively strict federal lending criteria. It is this pool of eligible non-qualifying borrowers that these new business models are targeting as they help their lending partners grow their non-QM portfolios.
Our firm has identified two demographics that lenders operating in the non-QM space plan to focus on: the self-employed and the foreign nationals legally working in the U.S. Self-employed individuals represent a fast-growing segment of the U.S. population. Moreover, in many cases (especially in the tech sector), these folks are making nice six-figure incomes, but they still cannot qualify for an agency conforming mortgage, according to current regulatory criteria. Foreign nationals living and working in the U.S. are another large and notably underserved mortgage loan demographic. This group mainly comprises highly educated individuals who typically have relatively high incomes, but they may have issues with their credit scores, such as a lack of a credit record or more difficult income or asset verification.
Although non-QM mortgage lending business models are still being developed, both bank and non-bank originators have clearly begun moving into the non-QM lending space. Some will still originate interest-only loans, and a number of providers today offer non-QM jumbo loans. As the previous discussion suggests, successful business models in this space often require thinking outside the regulatory box.
Despite the current growth in the segment and the reasons to expect more growth discussed previously, non-QM loans still have several hurdles to overcome before becoming mainstream. That said, most professionals in the mortgage industry believe that developments such as courts setting precedents regarding litigation and ability-to-repay guidelines in the near future will set the stage for rapid growth in the non-QM lending space.
Brad Walker is CEO and co-founder of Income&, a San Francisco-based peer-to-peer real estate platform and the pioneer of the PRIMO, a low-risk, high-yield, fixed-income product backed by hard assets. He can be reached at firstname.lastname@example.org.