Non-Qualified Loan

The Auto Lending Industry is Tightening Credit, How About Mortgages?

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Slowing demand in cars is causing automakers to cut down production to balance the rise in available inventory. April is the fourth month in a row where automakers report poor sales. Apparently, fewer Americans are buying cars now. But what caused this?

The possibility for disaster

You might be familiar of the subprime auto loan crisis that has recently grabbed headlines. A quarter of the American auto loan debt of $1.2 trillion is lent to high-risk borrowers or those who have not-so-stellar credit scores. As the panic sinks in among lenders, many tried to mitigate disaster by setting stricter guidelines and qualifications on their loan services and products. Now, a third of new auto loan originations are given to borrowers with FICO scores 720 and up.

The tightening of credit, along with the rise in interest rates is making it harder for many potential borrowers to get financing for their vehicle-buying intent. Many are reconsidering their intention to buy new cars, with others just settling for used ones.

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But the question right now is: is the mortgage sector following the auto loan sector’s example?

A new report from the Federal Reserve’s Senior Loan Officer Survey has shown that commercial real estate lending standards tightened in the second half of 2016 following a warning by the Office of the Comptroller of the Currency regarding the easing of loan standards for mortgage originations. An analysis of a sample of fusion commercial mortgage-backed securities spanning the period of 2012 through the first quarter of 2017 also showed a significant drop in LTV (loan-to-value) ratio this year which indicates that commercial mortgage-backed securities lenders are tightening credit as well.

Not again

Remember that the boom of subprime mortgages caused the collapse of the housing market and paved the way for the Great Recession back in 2008. Of course, nobody would want to take that disastrous dive once more. Still, this does not prevent many other private players from taking advantage of the lack in competition. Those who choose to do so are racking up $20.4 billion last year alone, a significant rise compared to $12.2 billion the previous year.

Not plunging into crisis is a collective effort. But in this game of risk and rewards, the intent is always individually-motivated. Are we mature enough as a collective to never make the same mistake twice?

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What’s the Catch with the Availability of Subprime Loans Today?

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What’s the Catch with the Availability of Subprime Loans Today-

Subprime loans seemed to have gone away forever after the housing crisis. After all, who would want to lend money to someone that cannot verify their income and risk facing default again? Certainly, none of the big banks ever want to go through that again. And the government even made sure that it was not possible with the new Dodd-Frank Act of 2010 and the Ability to Repay Rules that both made sure that the lender not only verified the income of every borrower but also ensured that they would be able to afford the loan well into the future or take the risk of the borrower being able to take legal action against the borrower. All that being said; however, subprime mortgages are making a comeback – so what’s the catch?

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More Requirements

There really is not a “catch” per se when it comes to subprime loans – they are simply an option for self-employed or heavily commissioned borrowers to get a mortgage. But just because they are able to state their income does not mean that they do not have to verify other things to ensure the validity and solidity of their application. Every borrower that states his/her income will have to have the following things evaluated:

  • Credit score – Most lenders want a credit score over 680, but every lender differs; some will be higher and others will be lower.
  • Assets – Every borrower will have to have assets and be able to verify them. These assets are how the lender determines if the income you state is true or not. For example, if you state that you make $100,000 per year, yet you have very little money in your bank account and no other assets to speak of, that $100,000 per year will be hard to prove. If you can prove the income, then it might make the lender think that you are in over your head as it is and cannot take on a new mortgage.
  • Employment – Someone has to verify your employment, even if you are self-employed. If you work for someone and make more than 25 percent of your income in commission, then your employer can verify your employment. If you are self-employed you can provide a valid business license or a letter by your CPA on his letterhead validating the existence of your business and the length of time it has been in operation.

In addition, you will likely need to put down a higher down payment. It would be hard to find a lender that would be willing to settle for the 3% down payment that you could find on a conventional loan with full documentation. Generally, you will have to put at least 20 percent down, but sometimes even more, depending on your risk levels and the risks the lender wants to take.

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Higher Rate

One thing that really stands out on the subprime loans is the higher rate you will have to pay. This is not to say that you will have an extraordinary rate if you are self-employed, though. Every loan has a different rate that is based on the following things:

  • Credit score
  • Amount of assets
  • Length of employment or self-employment
  • Debt ratio
  • Level of risk that you bring to the lender

There are adjustments for every category. For example, if your credit score is near the lower end of the threshold that the lender allows, then you will likely have a hit on your interest rate for that. In addition, if you are putting a lower down payment down or are new to the line of business that you are in, there will be slight adjustments in your interest rate for that.

Every lender differs in what they require and offer to each borrower. Make sure that you shop around with various lenders if you are interested in subprime loans. They are nowhere near as difficult to find today as they were in the past, so make sure you ask around in order to get the loan with the most attractive terms for yourself.

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Why Subprime Loans are Necessary Today

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If you say the word “subprime loan” to a banker, you will likely see him cringe in return. Bankers do not like the term subprime any longer and are not making subprime loans as of today, so to speak. What they are offering, are loans with a different name – Non QM Loans, which stands for non-Qualified Mortgage Loans. That sounds a little better, doesn’t it? It could be just because of the tarnished name that subprime got over the years of the housing crisis, but whatever the case may be, non QM loans are making a comeback and a necessary comeback at that.

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Qualified Mortgages are Not for Everyone

A qualified mortgage is a mortgage that meets very strict guidelines. These are the mortgages that Fannie Mae, Freddie Mac, FHA, VA, and the USDA will purchase and/or guarantee. These loans fit a perfect mold and are a perfect fit for certain borrowers – but not all borrowers! Unfortunately, the housing crisis did not only hurt the banks, it hurt consumers too. Many of these consumers have not quite bounced back to the point that they would fit the mold of standard, conventional lending. This leaves them without the ability to get a home, unless they obtain a non-QM loan. Getting around the QM guidelines, these lenders are requiring other mitigating factors to make up for whatever it is that prevents the consumer from falling under the Qualified Mortgage guidelines. Typically, it is the debt ratio that is making these loans non-qualified as 43% is the maximum to qualify. The borrowers that have lower credit scores are naturally going to be charged a higher interest rate, which then pushes their DTI over that threshold – making them “subprime.”

Getting More People into Homes

The Qualified Mortgage guidelines are pushing people that had recent credit issues away from owning a home, which is why the non-QM loans are making a comeback. These are the loans for people that had bad things happen to them – maybe they suffered a bankruptcy or foreclosure or maybe they defaulted on several credit lines as a result of losing their job or being downsized. These life events may have passed for these people and they are trying to make a name for themselves again, but with the stricter mortgage guidelines in place, it is becoming impossible.

Qualified Mortgage is not for everyone, consider a Non-QM loan»

Subprime Means Something Different Today

Just because a loan is non-QM today, does not mean that it must not meet the Ability to Repay Rules – yet another rule put into place by the Dodd-Frank Act. This rule states that each borrower must be able to pay the loan by proving their income and assets; be able to verify their employment; have all payments figured into their debt ratio that apply to the house as well as other monthly obligations; and have satisfactory credit history. To sum it up, it means that banks must do their due diligence to ensure that a borrower can in fact, afford the loan despite the slightly higher interest rate that may be charged. Lenders are still unable to charge excessive fees or provide risky terms, such as negative amortization or interest only payments. Basically, the borrowers allowed the non-QM loans are those that have a credit history that does not allow them to qualify for a standard loan yet they can prove that they can afford the loan.

If you are looking for a loan and do not fall within the conforming or FHA guidelines, non-QM loans could be your best bet. As long as you have compensating factors for your lower credit score or poor credit history, such as any of the following, you may have better luck than you think at getting a loan.

  • Excessive reserves/assets
  • Low debt ratio
  • High down payment
  • Stable employment history

More and more investors are realizing the profits to be had in the non-QM lending industry and the benefit it will have on the economy. Many lenders are still keeping these loans on their own books, but as more and more investors come forward, the funds will begin to pool and more non-QM loans will begin to flood the market, making getting a loan easier yet today, but not as easy as we saw in the early 2000’s.

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