Following the financial collapse of 2008, regulations were legislated to “protect” future borrowers from what some perceived as lender abusive behavior. Regulations initially resulted in tougher qualifying standards, denying some would-be home borrowers the ability to purchase. Gradually, the qualifying guidelines became more flexible and while some still complained of their eliminating some buyer prospects, the lending climate became more buyer friendly and protective.
One portion of the new rules related to Qualified Mortgages, called QM loans. This required lenders to apply old fashioned qualification standards to determine a loan applicant’s Ability to Repay (ATR). After early adjustment, the new requirements seemed to work. But from the beginning there were those who complained that adopting ATR compliance stifled many potential home buyers.
In 2018 the protective rules were mostly discarded and a banks were again granted relief from oversight and he door was opened for what became known as the non QM loans, sometimes referred to as sane subprime or non-conforming financing. Loans became available for the borrower with “less than perfect credit” or who may have a special circumstance and unable to acquire the QM financing. (see below forcommen t about these new loan instruments)
A little history may assist in understanding the reluctance of some lenders to move into this easy qualifying loan arena. This kind of easy qualifying loan had become a very important “niche” in the real estate arena prior to the financial collapse of 2008. There have always been “hard money” or “equity” lenders available but these sources had been traditionally used only in desperate situations. The rates, fees and pre-payment penalties made these loans a “last resort” effort.
Lenders developed what they called portfolio or niche loan products available to accommodate the borrower who needed special attention. While these loans may have had better rates and fees than the old hard money alternatives, there were some potential difficulties that many chose to ignore. Some aspect of these loans were:
– It was more expensive in rate and, often, in fees than the more conventional loan.
– The grades (Ax, A-, B+, B, C, D) referred to seriousness of the credit blemishes resulting in the lenders “risk” factor.
– The more serious the credit blemishes, the lower the Loan-to-Value (LTV) was likely to be.
When counseling a potential borrower, loan officers considered this kind of financing as “short term”. It required that a “plan of action” be prepared so that the borrower could presumably refinance into a less costly loan within 2-3 years. It was important to consider pre-payment penalties and make sure that if one existed the borrower considered how it might impact his/her ability to refinance into a better loan in the future.
As more flexible, automated underwriting guidelines were introduced, lenders were encouraged to first try to acquire a “conforming” loan. If it was determined that a borrower was unable to acquire a conforming type loan, they were supposed to be counseled very carefully regarding the risks involved with a niche loan. It was difficult to know exactly what loan would be obtainable for a borrower with very blemished credit. The loan package was typically submitted seeking the highest (Ax or A-) grade rating. Often, an investor determined the actual loan to be “offered” to the borrower only after reviewing the entire package. This was viewed as a “counter offer” for the borrower to either accept or reject. By carefully preparing the package, fully explaining credit difficulties and anticipating possible questions/problems in the file, if the borrower proceeded to a niche type loan the lender hopefully always tried to obtain the best possible loan option for the borrower.
More conservative lenders counseled the borrower to improve their credit, acquire additional down payment funds or to improve their loan profile sufficiently to obtain more conventional financing. The bulk of the niche financing loans were fixed only for those first 2 or 3 years and were designed to change to adjustable rate loans with substantially higher rates and payments. Too often borrowers were not adequately advised regarding whether they would be in a position to refinance at the conclusion of their initial loan period or that they would be able to afford the future adjustments to their payments. As it turned out, that is exactly what happened and many niche loan borrowers faced serious problems including the loss of their home to foreclosure. . In retrospect, we are pleased to say that we simply refused to make such loans and none, to our knowledge, of our past borrowers are among who faced foreclosure.
As with the old niche loans, most lenders, including Humboldt Home Loans, are “full service” to the extent that they have some form of niche products. Thus, if a borrower does not quite meet the criteria for an A paper loan, they need not go elsewhere and start the process all over again to obtain some form of financing. Any niche product must always be a very last alternative approach to funding a loan and not automatically the first option. Too frequently in the past, that was not the case for many lenders and the housing crisis was a result. Again, Humboldt Home Loans is proud not to have been a party to putting people into loans that they could not afford.
There is always some anxiety when one wants to purchase a home and is told they do not qualify. Understandably, these would-be buyers can be seduced into ultimately what can turn out to be less than desirable financing Many of the problems noted above with the old niche loans are present in the non QM loans of today.
– Most are adjustable rate mortgages – same may begin as fixed but convert to adjustable at some point in the loan term
– Higher rates and sometimes additional fees accompany the loan based upon the lender’s perceived risk with the borrower (low credit scores, no reserves, higher qualifying ratios)
– Pre-payment clauses usually accompany these loans
– The borrower does not know the actual loan terms until they submit a loan package and receive the “offer” from the lender.
– Infrequently, borrowers are counseled as to what is the next step into a better loan option – are they going to be able to refinance into better rates and terms?
Although Humboldt Home Loans has lender sources for the new niche products, we remain reluctant to make the loans for the reasons sited above. We suggest instead that there are still many good loan options available for borrowers but it can require “research” to determine the appropriate loan for a particular borrower’s needs. If you feel you may require some special counsel in preparation for home financing, call Humboldt Home Loans today for a FREE consultation interview. We will help you explore all of your loan options.
Be Cautious With the New Non-QM Financial Options
The new “more flexible” loan instruments are called variously non-QM, non-prime or sane sub- prime. By any name, these new loan options are a step back toward the days prior to the 2008 through 2012 recession. The selling point of the new loans is their willingness to accept borrowers with low credit scores, recent bankruptcies or foreclosures and late mortgage and credit payments.
Typical conventional home loans require somewhat rigid 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 obtain competitive interest rates and terms.
In contrast, the new non-QM products are riskier and therefore require greater down payment amounts, higher rates and cost, shorter terms and are mostly adjustable rate mortgage loans. Granted, the new market does require some “skin in the game” with down payments (whereas the past sub-prime often included 100% financing) and the borrower pays for the greater risk via higher interest rates. Down payments also tend to reduce the risk that the owner will end up with no equity even n the event of a downward turn in the market.
The shorter terms, some as short as three years, can be alarming. The anticipation is that borrowers can within the three year term 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 appreciation wasn’t obtained, especially when the market unexpectedly and suddenly declined.
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 before they borrower is eligible to pursue a refinance. In spite of the intentions, a refinance may not be possible due to market changes during any lock-in period.
Like any loan instrument, these more flexible loans MIGHT be useful to some borrowers. Self-employed borrowers, for whom fully documented loans are more difficult, might use this type of financing. The concern is for those who use the riskier loan options only to discover that they have placed themselves in a precarious position with adjusting rates, declining values with lack of equity and other aspects that caused sub-prime loan borrowers to lose their homes to foreclosure.
It is recommended that would-be home buyers acquire a pre-qualification during which they learn about the various loan options available to them. If there are credit issues, learn how to correct them. Determine your personal “road map” to home ownership. Postponing a home purchase and patience with the loan process may be the safest route to obtaining the American Dream.