Today’s Non QM loans can be confused with the infamous sub-prime loans so prominent from 2004 through 2008 and which are blamed for the market collapse of 2008. While not risk free, the new loan options can be an alternative for some borrowers in some situations. Non-QM loans are a growing part, although currently still a small portion, of the mortgage industry
These new “more flexible” loan instruments have been called variously non-QM, non-prime or sane sub- prime. By any name, these new loan options are safer than the past sub-prime mortgages. The selling point of the new loans is their relative flexibility for qualifying borrowers when compared to the Conventional array of mortgage options.
Typical conventional home loans require somewhat more firm qualifying requirements to assure the borrower’s ability to repay the mortgage. These Qualified Mortgages (QM loans) provide some safety to both borrowers and lenders as they focus on credit scores, borrower assets and stability accompanied by adherence to qualifying ratios. Thus, borrowers primarily obtain competitive fixed interest rates and terms.
The Adjustable Rate Mortgages (ARM) is part of the conforming or QM array of loan options. Lower initial interest rates is the prime alure of the ARM loan. these products have terms like 3/1, 5/1, 7/1 with the first number representing the number of years and the second number representing that annual rate adjustments can occur. As fixed rates climb, the ARM loan offers for some a temporary option during which time the market might change or the borrower might refinance or sell.
In contrast, the new Non-QM products are mostly Adjustable Rates but with higher initial rates and requiring larger down payments the conforming ARMs. These creative loans are riskier in that they allow for more flexible qualifying guidelines. They also often require less paperwork and quicker loan process. The requirement that the borrower have some “skin in the game” with larger down payments (whereas the past sub-prime often included 100% financing) reduces the risk to the lender as well as some protection to the borrower who is more likely to end up with some equity in the event of a downturn in the market.
The shorter terms, some as short as three years, can be alarming but these products are anticipated to be interim financing arrangements. The idea is that borrowers can within the three year term (some are longer terms but the interest rate increases proportionately) improve their credit while the property increases in value allowing for a refinance into a “better” loan after the initial period. This was the same expectation with the old sub-prime loans but too often credit wasn’t improved and home appreciation is not guaranteed.
To complicate a potential refinance is the fact that these non-QM loans can include a pre-payment or early payoff penalty which acts as a sort of lock-in period should a borrower seek to refinance prior to the expiration of the pre-pay period.
A brief history of the past sub-prime loans may assist in borrowers avoiding the mistakes made by many past borrowers.
In the most recent past, niche or sub-prime financing meant non-conforming or non- Fannie Mae loans. The non-conforming market essentially served those borrowers who weren’t able to qualify for conforming loans either because of damaged credit, such as a Bankruptcy, lack of credit or down payment funds and sometimes very low credit scores, etc… these were all structured as niche or non-conforming loans.
These loans also became popular with borrowers who preferred to provide little or no documentation in the approval process. Relying instead on high credit scores for qualification purposes, the “stated” income or the “no income” verification loans allowed for minimum documentation to be provided. Self-employed individuals often benefited from these type loans as did those borrowers who are trying to stretch into a home purchase. Borrowers with high credit scores sometimes decided that the convenience of acquiring their loan outweighed the bump in the interest rates.
The stated income and no-doc loans were originally designed for self-employed borrowers whose income was more difficult to verify. But, in the desire to increase borrowers’ ability to qualify, these loans were introduced to wage earners. The result was a rash of what were called “lier loans” in which borrowers exaggerated their income in order to qualify for loans that proved to be beyond their capacity to pay. These loans have now all but virtually disappeared.
The differences between conforming and non-conforming loans were small. The niche loans were originally designed to help a borrower obtain financing for a home while providing time to fix whatever was wrong with their credit, income or asset issues. The rates, even for the credit challenged, were surprisingly good, all things considered. The terms were normally amortized over a 30-year period, but fixed for 2-3 years after which they would turn into an ARM. The assumption was that it would take no more than 2 or 3 years for the borrowers’ credit, income or asset issues to be repaired, after which the borrower would have the option of refinancing into a Fannie Mae conforming loan. Unfortunately, home values peaked and, in some cases, declined making refinancing impossible. In other cases, borrower’s hadn’t repaired their credit situations sufficiently to qualify for new financing. The result was many borrowers facing loan adjustments that were unaffordable and resulted in foreclosures.
The non-conforming market was one of the fastest growing segments in the mortgage industry because of its flexibility and ease with which borrowers were able to purchase. While some Adjustable Rate Mortgages (ARM’s) remained available, the fixed rate loan became the more popular choice. We are also now experiencing a less flexible loan environment and tightening qualifying standards. The qualifying guidelines are constantly being revised and much more is now required to determine a borrower’s ability to qualify for a loan.
Returning to today’s Non QM products, it is clear that they are safer in that they now require the borrower to “qualify” for the loan. The qualifying guidelines are much more flexible than conforming loans and, as indicated above, generally require less paperwork.
These new loans offer longer fixed terms (3, 5, 7, 10 years) before an initial rate adjustment occurs. They also offer the self-employed borrower qualifying options that make the higher rates acceptable. Bottom line, Non QM loans offer alternatives that no longer should be routinely dismissed but borrowers are urged to review all available loan options and fully understand all aspects of their loan choice.
You will find more information in the tip sheet section of this webpage and you are invited to discuss your specific situation with us at Humboldt Home Loans and we will advise you accordingly.