Mortgage lenders are trying to extend credit to borrowers with dinged credit but plenty of assets. The problem is that many of these mostly self-employed borrowers can't qualify for mortgages because their income can be uneven or they are carrying too much debt.
Now Impac Mortgage, the former alternative-A lender that managed to survive the financial crisis, is lowering its underwriting guidelines in hopes of turning some of those rejections into approvals.
Bill Ashmore, the president of Irvine, Calif.-based Impac, revamped the company's guidelines last week. Impac now has a product that allows borrowers to qualify based on their bank statements, assets or a combination of both. That flexibility helps qualify borrowers who might have high debt-to-income but strong cash flow.
Impac also loosened restrictions around credit. A borrower now must have a minimum of five credit lines, either open or closed, though one must have at least a $5,000 credit limit and another must have been open for at least for 24 months. Previously, a borrower had to have at least five open credit lines in order to qualify for a mortgage.
Ashmore said that the lender's guidelines were so tight that it was only closing three out of 10 loans, "when I need to close six." The company recently bought the home loan division of Cash Call, a call center that originates loans in roughly 40 states, and Ashmore said it needed to revamp its guidelines to meet the recent surge in demand.
"I did an analysis of all these loans that were turned down, and all of them were good loans. I said, 'if we tweak it here and there, we can capture more good loans,'" he said. "We don't think this increases our risk at all."
The fact that Impac is lowering its underwriting guidelines shows that the market for home loans that fall outside the Consumer Financial Protection Bureau's definition of "qualified mortgage" is still struggling to take off. While non-QM lenders exist, their lending is hampered by several factors, including high origination costs and a wariness among warehouse lenders and investors to fund non-QM loans. Some lenders also are finding that consumers, even those with dinged credit, are not too keen on paying a mortgage rate of 6% to 7% or higher, when interest rates are at historic lows.
It's hard, too, for non-QM lenders like Impac, which has a partnership to sell loans to Sydney-based Macquarie, to compete with Fannie Mae and Freddie Mac. The government-sponsored enterprises have the legal authority to back non-QM loans with debt-to-income ratios above 43%, and still call them "qualified mortgages."
Of course, non-QM loans come with significant legal risks. The "ability-to-repay," rule, a crucial provision of the Dodd-Frank Act, requires that lenders consider eight specific underwriting factors to verify the borrower's income.
Failure to do so can result in possible criminal liability, fines of $5,000 per day, enforcement actions by federal and state agencies, and civil and class action lawsuits by individual borrowers. Borrowers have three years to bring a legal action against a lender for potential violations of the ability to repay rule and also can raise a defense to a foreclosure.
Impac is targeting the borrowers with a minimum Fico score of 680, and a maximum loan-to-value ratio of 80%.
"There's a number of non-QM investors that have gone after the lower end of the credit spectrum," said Nancy Pollard, an executive vice president at Impac. "We still want fairly good credit but we're willing to look at different documentation. There are some borrowers out there that just can't get credit today because under QM they may not qualify."
Deutsche Bank estimates the non-QM market has roughly $50 billion a year in originations, but most of that is currently going to Fannie Mae and Freddie Mac.
Non-QM lenders are at a huge funding disadvantage relative to Fannie and Freddie. The GSEs were given a seven-year exemption from the qualified mortgage rule. So some borrowers with debt-to-income ratios above 43% can get a government-backed mortgage if it passes Fannie or Freddie's automated underwriting engines.
Roughly 14% of home purchase loans backed by Fannie and Freddie had DTI ratios exceeding 43%, according to May data from the American Enterprise Institute. The Federal Housing Finance Agency, which oversees Fannie and Freddie, would not confirm the data saying it has not been publicly released, a spokeswoman said.
Ying Shen, Deutsche Bank's co-head of residential mortgage-backed securities research, thinks non-QM lending could top $400 billion once Fannie and Freddie are no longer in conservatorship.
"Right now, there are a lot of lenders trying to target this type of customer, but not too many takers," Shen said.