any originators are missing opportunities in the home-finance market
because they don’t fully grasp a fundamental requirement affecting all
non-qualified mortgages — which is ensuring that
the borrower has the ability to repay the loan. In the
world of non-qualified mortgages, or non-QM, many
originators are not clear on the concept of ability to
repay and the characteristics that are most important
to meeting the requirement.
So, how and when did ability to repay, or ATR,
become the standard for the non-QM industry? It
started with the Dodd–Frank Wall Street Reform and
Consumer Protection Act, which was signed into law
by President Barack Obama some eight years ago.
The ATR standard embodied in Dodd-Frank requires
lenders to make a reasonable, good-faith
determination of a consumer’s ability to
repay a mortgage that is secured by a
dwelling for personal use — a rule that applies to qualified mortgages and non-QM loans alike.
How we got here
All owner-occupied and second-home transactions have to abide by the ATR mandate. Lenders
are required to analyze borrowers’ income documentation to determine their ability to repay the
mortgage. Again, it’s important to remember that
properties owned for business purposes, such as
investment properties, are exempt from having to
conform to ATR rules and regulations.
The underlying logic of ATR with respect to
homeownership is based on ensuring that borrowers are provided loans with payment terms
they can afford — meaning they are conservatively calculated based on their income history over
the prior 24 months. It is a common mistake for
originators to use the loan-to-value ratio (LTV) as
a compensating factor when evaluating the viability of a loan. Establishing a conservative LTV is
a favorable factor for a lender in the case of payment default, but it is completely irrelevant to the
income analysis applied to the borrower’s ability
ATR can become a particularly thorny area in
the case of nonprime loans, which are a subcategory of non-QM products. The distant cousins
of these higher-risk loans were called subprime
loans, and prior to the housing crash 10 years ago,
they commonly were offered to borrowers with
a history of delinquent payments or other black
marks on their credit. In fact, these so-called subprime loans were blamed for helping to spark
the housing crisis — given many subprime loans
at that time were prone to default because they
were poorly underwritten, often relying on little
to no documentation.
Many have questioned the rising popularity of
nonprime loan programs, arguing that they are just
another form of the subprime loans that caused so
much havoc in the industry a decade ago. Those
assumptions are wrong, however, because the
subprime loans of that era would not pass muster
under the ATR rules that non-QM loans, including
nonprime mortgages, have to meet today.
Attempting to help struggling homeowners refinance their existing failing mortgage, for example,
would be virtually impossible under today’s ATR
standards. Think about it. How could a lender justify
the transaction when the loan that is being used to
refinance the failing loan and bail-out the borrower is itself proof of the borrower’s inability to repay
the underlying mortgage? In order for a nonprime
lender to refinance a mortgage, the borrower must
demonstrate the ability to repay by bringing the
existing loan current.
Another factor to consider with respect to the
opportunities opened up by nonprime loans relates
to bank-statement loans. Such loans have become
quite attractive for self-employed borrowers who
don’t have traditional paychecks and are unable
to qualify for mortgages under the documented-income requirements established by agency guidelines and banks. Such bank-statement programs
are of use for non-QM and nonprime loans because
they allow a lender to evaluate the borrower’s
bank records to establish income and to determine
if there is a history of insufficient-funds notices.
Too many notices of insufficient funds on bank
statements, for example, point to an inability to
repay because they are an indication that the
borrower is unable to manage their finances.
A way forward
By applying ATR in new ways, more non-QM opportunities begin to open up. Loan programs offering a five-year fixed rate with fully amortized and
indexed payments are one such opportunity, for
example. A borrower may get a lower rate with a
five-year fixed mortgage, but that rate is not used
to determine the borrower’s ability to qualify and
the maximum allowed LTV ratio.
Instead, it is common practice for lenders in underwriting the loan to assume a 2 percent increase in
the rate or the fully indexed rate, whichever is higher.
This more conservative approach enables originators to offer products that might seem risky in name,
but actually abide by the concept of ability to repay.
Interest-only loans represent another opportunity.
Originators typically consider interest-only loans as
a way of helping a borrower qualify by making payments lower and more affordable at the initial period
of the loan. Of course, for many borrowers, these loans
can prove to be the complete opposite of affordable.
For more articles on the
View these articles and more at
“Are We Ready for Non-QM Lending?”
“Grab a Slice of Purchase Pie,”
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