The failure to appropriately qualify applicants for a mortgage loan combined with less stringent underwriting standards have been cited as two key factors in the events that led to the 2008 financial crisis. This has led to various regulatory changes, including the requirement that lenders verify the applicant’s ability to repay the mortgage obligation. This requirement was part of the Ability to Repay (ATR) rule. The ATR rule, among other things, classified loans into certain categories, including Qualified Mortgages and non-Qualified Mortgages.
The volume of non-Qualified Mortgages has increased in recent years. In fact, lenders issued $34 billion dollars of Non-QMs in 2018, a 24% increase from the same period in 2017, according to Inside Mortgage Finance. The obvious concern here is that Non-QMs could bring about another financial crisis in the future. Which begs the question, what has changed since 2008?
First, the primary difference between the Non-QM loans originated today and the loans contributing to the financial crisis in 2008 is the ATR rule, implemented in 2014. Prior to the ATR rule, some lenders were approving borrowers for mortgages with little to no verification of their employment, income and other debts. Since the ATR rule has been implemented, lenders are required to evaluate, at minimum, these 8 underwriting criteria:
- Current or reasonably expected income/assets
- Employment status
- Monthly payment on the mortgage loan the applicant is receiving
- Monthly payments on any simultaneous loans the creditor knows or has reason to know will be made
- Monthly mortgage related obligations
- Current debt obligations, alimony and child support
- Monthly debt-to-income ratio or residual income
- Credit history
Thankfully, while experts like the credit rating agency Dominion Bond Rating Service (DBRS), and publications like The Wall Street Journal have conceded that the rise in Non-QMs could be worrisome, it is believed the new ATR rule will prevent the events of 2008 from being repeated.
Next, who benefits the most from a Non-QM? The easy answer is anyone who has been turned down for a conventional or government-backed loan. But keep in mind the purpose of the ATR rule, which is to prevent lenders from providing financing to those who cannot afford it, and to identify the borrowers who can. According to DBRS and bankrate.com, here are a few examples of borrowers who rely on Non-QMs to secure financing:
- Self-employed borrowers– These borrowers generally have sporadic pay and multiple income streams, making it hard for them to get qualified for a traditional mortgage. Many self-employed borrowers get bank statement loans, which are based on cash flow and liquid assets.
- Foreign nationals– Non-resident borrowers who want to purchase property in the U.S. often have trouble qualifying for traditional mortgages because of low or non-existent U.S. credit scores. Typically, Non-QM lenders use international credit reports, liquid assets and large down payments to qualify foreign nationals.
- Borrowers with significant assets– A Non-QM loan called the “asset qualifier program” is used to qualify borrowers with substantial assets. The assets are often enough to purchase the home outright, but the borrower chooses to finance in order to maintain cash flow.
In short, while Non-QMs are making a resurgence in today’s lending market, these loans have more stringent underwriting requirements than the loans involved in the financial crisis of 2008. As you can see, there are a number of borrowers who don’t meet traditional lending standards but do have the assets necessary to secure home financing. Despite the concerns of some, as long as the ATR rule is followed by lenders issuing Non-QMs, it appears the risk is worth the reward.