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38 | TH E M R EP O RT FEATURE to show they have sufficient income and assets, or by taking other compensating factors into consideration. The key to mitigating the risk of non-QM lending is to look at the total picture and take into account all of the characteristics of the loan and the borrower. For example, non-QM loans with high DTIs can be offset by requiring borrowers to have high FICO scores or a low loan-to-val- ue (LTV) ratio. A borrower's high DTI could also be offset through assets and reserves. A non-QM loan, then, should be considered safe as long as the lender is able to prove the risk was justified, which is done by looking at com- pelling compensating factors. On the other hand, there is cer- tainly greater risk with non-QM loans that allow limited or alterna- tive documentation for proving a borrower's ability to repay. For self- employed borrowers, who make up a large proportion of non-QM borrowers, this generally means relying on bank statements instead of business and personal tax re- turns. But, anytime a lender relies on fewer documents to validate a borrower's income and assets, it comes with an increase in risk. Taken one step further, allow- ing a combination of both high DTI and limited or alternative documentation on a non-QM loan poses an even greater and unnec- essary risk. By originating loans with both factors present, lenders are expanding the credit box without getting the full picture of the borrower's income. This type of activity is problematic and pushed to extremes, it could lead to another credit crisis. The Right Direction? C urrently, there is confusion about what actually consti- tutes a non-QM loan. While the CFPB's QM rule and its defini- tions are relatively clear, an excep- tion to the 43% DTI limit has been made for Fannie Mae and Freddie Mac. All loans backed by the GSEs are automatically considered QM as they required temporary relief until January 10, 2021, or when the GSEs are released from conservatorship, whichever comes first; however, both the government sponsored enterprises (GSEs) bought loans with DTIs as high as 45% until July 2017 and then raised that limit to 50%. This exemption is currently re- ferred to as the GSE QM "patch," and as of this writing, there has been discussion in Washington, D.C. regarding if and how long it will be allowed to continue. Either way, this situation has cre- ated a confusing double standard. In fact, as a result of the patch, as many as a third of loans sold to the GSEs have DTIs over 43% percent, yet they are still consid- ered QM compliant. The current overall level of risk tolerance for non-QM loans is still nowhere near the depths we saw before the last housing crisis. But as the credit box continues to expand, an unchecked appetite for risk could lead us down the same destructive path. For example, a change in the political landscape or trade policy could trigger a slow- down in the U.S. economy, which could lead to job layoffs. Combine such a scenario with over-appre- ciated home values, and we could be looking at another perfect storm of events that place everybody at risk, especially banks and servicers with a large number of high-LTV loans on their books. The bottom line is that lenders should never be in the business of putting people into homes they cannot afford. An ideal housing market is one in which consum- ers who deserve mortgages get them, so long as they are able to show they have the ability to repay. By demonstrating an abil- ity to pay, non-QM lenders can have some confidence that they are matching consumers with the right loans and supporting healthy homeownership. But once again, the question is how lenders are demonstrating this because there really are no clear set of rules or guidelines. I truly believe that's where we are today, but things could always change. Famed Chicago journal- ist Sydney J. Harris once wrote that "history repeats itself, but in such cunning disguise that we never detect the resemblance until the damage is done." The more lenders continue to expand the credit box to make up for lost production, the more risk they will incur. If we hope to avoid the mistakes of the past, it's a situation well-worth keeping an eye on. ELLIOT SALZMAN is the Chief Credit and Compliance Officer for LoanLogics, a recognized leader in loan quality technology for mortgage manufac- turing and loan acquisition. Salzman has more than 25 years' experience in the mortgage industry and has held numerous executive roles overseeing operations and credit policy. By extending credit to borrowers who do not fit qualified mortgage rules, lenders are hoping to keep their loan pipelines full and protected, and even benefit ... But what sort of price is to be paid for relaxing credit standards?