TheMReport — News and strategies for the evolving mortgage marketplace.
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36 | TH E M R EP O RT FEATURE T here's little doubt that the non-QM loan volume is growing, and that lenders and inves- tors are showing an increasing ap- petite for an expanded credit box. It's also obvious that the increased risk tolerance for non-QM loans is being driven by lenders' desire to capture as much market demand as they can in a favorable rate environment. What isn't as obvious is where all this is heading. With the volume and types of expanded credit options likely to continue to increase in the near future, some are beginning to question how much risk lenders and inves- tors are willing to take on, and whether the growth of non-QM lending should be looked at as some sort of red flag. After all, the mortgage industry has a habit of forgetting about its past. It might be too early to sound any alarms, but these are still good questions to ask. While certain lending behaviors that directly contributed to the last housing crisis do not appear to be taking place today, it's worthwhile to examine how and where the tolerance for risk in the non-QM market is growing, and what lenders can and should be doing to stay out of trouble. Five Years After QM W hen the Consumer Financial Protection Bureau (CFPB) adopted the qualified mortgage (QM) rule in 2014, the mortgage industry was running mostly on government paper. That's still the case today. In fact, according to CoreLogic, the total non-QM loan market only made up about 4% of total mortgage originations in 2018. Yet the non-QM market is steadily growing, with new types of mort- gage products being introduced every month, including loans with fewer document requirements, high debt-to-income (DTI) loans, and even interest-only loans. There is no bigger driver behind non-QM mortgage loans than the need to maintain or expand production. Indeed, in spite of declining interest rates and low unemployment, there have been several signs recently that purchase origination volumes might be tapering off. In its August market fore- cast, the Mortgage Bankers Association reported that 30-year fixed rate mortgage rates had fallen more than one percentage point since reaching a high of 5% in November 2018, causing the MBA to project a 38% increase in refinance volume and a 5% increase in purchase volume for 2019. However, the MBA is also predicting that economic growth will "slow to a halt" in early 2020 and possibly enter a recession, due to a combination of economic factors, including the current inverted yield curve. By extending credit to borrow- ers who do not fit qualified mort- gage rules, lenders are hoping to keep their loan pipelines full and protected, or even benefit since non-QM loans allow them to charge more than QM loans. But what sort of price is to be paid for relaxing credit standards? Compensating for Risks I t's well-recorded that govern- ment agencies are tolerating higher levels of risk. According to an October 2, 2019, Washington Post article that cited data from the Urban Institute, about 30% of Fannie Mae loans involve payments that are nearly half of the borrowers' monthly income and 25% of new FHA-guaranteed mortgages had DTI levels over 50%, the highest level in nearly 20 years. Any time lenders and investors loosen their require- ments—whether it's by lowering allowable FICO score require- ments or accepting higher DTI ratios—they're inviting risk, that's likely to result in a rise in delin- quencies and defaults. Fortunately, the mortgage industry is nowhere near the free-for-all that existed back when lenders were handing out stated income loans like they were candy to borrowers with poor credit. That's mostly because non-QM lenders must still meet Dodd-Frank requirements to verify a borrower's ability to repay. The challenge is how to do so since there is no standard for evaluating non-QM risk. The key is using compensating factors to offset one or more other, less-than-ideal factors, whether it's the borrower's low credit score or an interest-only loan. Lenders also have the opportunity to use other industry standards such as resid- ual income tests to offset non-QM risk. There are many different reasons why a loan is designated a non-QM loan, however, and some of these reasons are easier to offset than others. According to a CoreLogic report from March, the three most common reasons why non-QM loans did not fit the QM definition are high DTI levels, the use of lim- ited or alternative documentation, and interest-only loan characteris- tics, in that order. In fact, 46% of non-QM borrowers had DTIs over the 43% QM limit, while another 44% of non-QM loans involved limited or alternative documenta- tion from the borrower. Loans with high DTIs appear to be the fastest-growing type of non-QM loan. According to CoreLogic stats, the share of non-QM loans exceeding the QM threshold of 43% grew more than three times from 2014 to 2018. Nevertheless, the risk of default for high-DTI non-QM loans is low—as long as the borrower has provided all the documents Risk and Reward It's time the industry examines how and where the tolerance for risk in the non- QM market is growing, and how lenders should be acting in response. By Elliot Salzman