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Sub-prime, or “non-prime,” mortgage lending returned to the market almost three years ago and with it, many critics who understandably voiced concerns that history would repeat itself. Lenders who decided to venture into this new landscape and tap a borrower base of Americans unable to secure traditional financing were faced with an uphill battle on how the general population perceived sub-prime.
Today’s products aren’t the same as the sub-prime loans that led to the housing crisis. In fact, sub-prime/non-prime today is quite different. New regulations have helped to ease these products back into the market. The skeptics are starting to come around and realize that today’s mortgages are proving to be much less risky than their predecessors.
Unlike the sub-prime loans of 2006, today’s loans have guidelines in place to alleviate risk. Here is a breakdown of what’s different today:
►Ability-to-Repay (ATR): ATR is one of the many regulations that resulted from the Dodd-Frank Act. ATR requires that originators look at a potential borrower’s complete financial picture to make sure their existing debt obligations plus the new loan amount won’t surpass a reasonable percentage of their income. Despite popular belief, non-prime loans still need to adhere to ATR standards.
►Skin in the game: Higher downpayment requirements mandate that borrowers provide a significant contribution towards closing the loan. Borrowers with the riskiest credit profiles are required to put down the highest downpayments to further compensate for that risk. This practice of ensuring prudent loan-to-value (LTV) ratios lessens the chances of default.
►No prepayment penalties: Today’s sub-prime loans do not come with a pre-payment penalty on them. At any time, a borrower can refinance to a conforming loan without having to pay a penalty on their existing loan.
►Appraiser Independence Regulation (AIR): Another result of Dodd-Frank Act regulations, AIR ensures that appraisers are truly independent and the LTV is accurate. Prior to Dodd-Frank, appraisers worked for the loan originators. This was a clear conflict of interest, but new regulation removes that conflict.
►Better credit scores: The average credit score of sub-prime loans in 2006 was 580. Angel Oak Mortgage Solutions portfolio of non-prime loans’ credit scores average about 680. The credit quality of these loans has increased significantly in the new era.
Although non-prime mortgages fall outside the QM safe harbor, the next generation of non-prime lending is proving to be very safe. In fact, Angel Oak Mortgage Solutions has only had three loans go into default since we started originating two-and-a-half years ago. The challenge with these new regulations, however, is that they require a well-documented, manual underwriting process that cannot be automated; however capable lenders with expertise in due diligence procedures stand to take advantage of bringing these products back to market while avoiding excess risk.
Tom Hutchens is senior vice president of sales and marketing at Angel Oak Mortgage Solutions, an Atlanta-based wholesale lender currently licensed in 24 states. Tom has been in the real estate lending business for nearly 20 years. He may be reached by phone at (855) 539-4910 or e-mail Info@AngelOakMS.com.
This article originally appeared in the April 2016 print edition of National Mortgage Professional Magazine.