The Case for Non-Qualified Mortgages – A Two Part series

Part Two- The Case of Non-qualified Mortgages

Introduction

In the first part of the article we noted that the ability to repay rules make a demarcation between “qualified” and non-qualified mortgages.   Qualified mortgages must have the following characteristics: 

• The borrowers debt to income ration cannot exceed 43 percent
• The points and fees on the loan cannot exceed the cap established in the regulation^[1]
• May not have balloon payments
• May not contain interest only payments
• May not exceed 30 years

 

We noted that if the loan terms do not meet these parameters, then the loan is considered nonqualified and a lender must meet the ability to repay standards.  The ability to repay standards include specific components which are designed to document that a lender has established the borrower’s ability to repay a loan under the worst case circumstances of the terms of the loans. 

 

We noted further that many lending institutions have taken the stance that in the face of these rules, they will only make qualifying mortgages.  However, several prudential regulators have made it clear that avoiding nonqualified mortgages was not the intention of the regulation.   On the contrary, there are several legitimate reasons why “thinking outside the box” and making nonqualified mortgages should be considered.  

 Why make Non-Qualified Mortgages 

For purposes of this discussion, it is important to point out that the borrowers who require nonqualified loans fit into two rather extreme categories.  There are the very wealthy borrowers whose financial characteristics don’t fit into the traditional borrowers.  These are borrowers who may have highly liquid assets, but irregular income.  Or perhaps these borrowers want a “bridge” loan to buy a house while they await completion of a large business transaction that will result in an influx of cash.   For these borrowers the need for nonqualified mortgages is largely an accommodation. 

The second set of borrowers are the potential homeowners in low to moderate income areas.   These borrowers tend to be outside of the qualified loan parameters through economic circumstances that without some level of assistance will result in continued struggle.   It is this second set of borrowers that we have in mind in the remaining discussion. 

Increased interest margins- Non qualified loans generally present a higher level of risk than qualified loans.  As a result, higher loan fees and rates are appropriate.   This is in no way meant to say that lenders can return to the bad old days of predatory lending.  Remember that the regulatory requirement is that the lender must prove that they have documented the borrowers’ ability to repay the loan.  The calculation must be made while considering the worst case scenario for the borrower. [2]

When considering these loans, it is also important to remember that with the proper underwriting, even though there is higher risk, the performance of loans in lower to moderate income neighborhoods has been actually equal to or better than the performance of other neighborhoods.  For example, a study performed by the Federal Reserve Bank found that during the financial meltdown of 2008;

Federal Reserve researchers also report that subprime mortgages made in CRA-eligible neighborhoods perform at least as well as those made in similar non-CRA-eligible neighborhoods, that a Large national affordable mortgage program has substantially lower defaults than the subprime segment, and that the majority of recent foreclosure filings have occurred in non-CRA eligible middle- and upper-income neighborhoods. [3]

 

Reduced Competition – Just because so many financial institutions have eschewed the non-qualified mortgage doesn’t mean that the need for these loans has disappeared.  In fact, the fear of what might happen with non QM’s has left a void.   As a result there is actually a strong market for non QM’s and the lender who decides to enter the market can have the virtual “pick of the litter”.  

In 2013, three former regulators with the CFPB saw this opportunity and launched an investment firm that provides financing for investors in the Non QM resale market.    The first venture of the firm was to launch a wholesale mortgage company. The venture table funds non-QM loans and assume all the risks from the lenders.

Minimal Infrastructure Changes – The whole point of the ATR rule is that lenders must develop sound systems for determining that a borrower can repay a loan.  The essence of the regulation is acting in a safe and sound manner.  For those institutions that wish to thrive and survive, safe and sound policies and procedures should be a daily practice.  The steps that are required to meet the ATR rule should be second nature

Meeting the Credit Needs of the Community – Many lenders talk about meeting the credit needs of the community in their Community Reinvestment Act statements.  Of course, more often than not, this statement is theoretical and can’t really be documented.   A program that allows first time homebuyers with a legitimate chance at asset acquisition is one of the largest credit needs of most communities across the country.  There are a number of institutions that have recognized this need and have developed successful lending programs that are couple with credit counseling.  The results have been excellent.    Both Time Federal Savings of Medford Wisconsin and Geddes Federal Savings in Syracuse NY have implemented non QM programs for first time homebuyers with unquestioned success.   

The CRA rewards innovation- for lending institutions that are subject to the Community Reinvestment act, there is a strong reward for innovative lending practices.    

“[The] ending Test also favors the use of innovative or flexible lending practices “in a safe and sound manner to address the credit needs of low- or moderate-income individuals or geographies.”[4]

  

The development of a lending program that allows nontraditional borrowers to obtain mortgages can lead to an outstanding CRA rating. 

 

In the end, there is absolutely no reason to run away from Non-qualified mortgages.   The potential for good results far outweighs the risk. 

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[1] These caps are specified in the regulation and vary depending on the size of the loan.

[2] In this case, worst case means, when all of the highest rate increases and fees have kicked in. 

[3] Glenn Canner and Neil Bhutta, Memo to Sandra Braunstein “Staff Analysis of the Relationship between the CRA and the Subprime Crisis”

(November 21, 2008), available at http://www.federalreserve.gov/newsevents/speech/20081203_analysis.pdf.

[4] Federal Financial Institutions Examination Council (FFIEC), “A Guide to CRA Data Collection and Reporting,” (January 2001), available at

http://www.ffiec.gov/cra/guide.htm.