The mortgage industry had a banner year. Loan originations for 2020 were expected to reach nearly $3.6 trillion, second only to 2003’s all-time high of $3.8 trillion, according to the Mortgage Bankers Association’s December forecast. Refinances fueled the boom as many lenders struggled to keep up with a barrage of homeowners taking advantage of record low rates.
But one segment of the market didn’t fare as well. Nonqualified mortgage lending came to a standstill in March. Non-QM loans, as they are known, are a small but significant segment of the mortgage market. These tend to be high-value home loans that are not backed by the Federal Housing Administration, Fannie Mae or Freddie Mac.
In 2014, in response to the housing crisis, the Consumer Financial Protection Bureau put in place the qualified mortgage or QM rule. Basically, if a loan met certain standards, it would receive the government backing of FHA, Fannie or Freddie. If it did not, it would be considered a non-QM loan.
Even though non-QM loans are considered riskier than QM loans, they should not be confused with the subprime loans that were at the center of the housing crisis.
After cratering in March, underwriting of non-QM loans has picked up. To learn more about what happened to the non-QM market this year and where it is headed in 2021, I spoke with Tom Hutchens, an executive vice president production at Angel Oak Mortgage Solutions in Atlanta. He is a non-QM broker who has experienced firsthand the substantial growth of this market. Our conversation has been lightly edited.
Q: What happened to the non-QM market when the pandemic first hit?
A: There were two factors. The first was investors that invest in the non-QM market do that through the bond market, through securitizations. In March 2020, there was a worldwide flight to cash, regardless of non-QM, commercial, whatever bond bondholders owned, they were cashing them all in. I think people forget; we didn’t know if we could get food, we didn’t know if we could get toilet paper again. It was just crazy times. The bond market froze, and the bond market is what the non-QM market is built around.
That was the primary reason. The secondary reason is that with non-QM loans the performance is not guaranteed by the government, which is what makes them non-QM. We, meaning really the entire market, we were not able to really determine somebody’s ability to repay because government was shutting businesses down, shutting industries down. We don’t have a government guarantee. So if we give a loan to a borrower on Monday and the government shuts their business down on Tuesday, that’s not good for us. There were so many question marks around so many things that the industry had to put a pause on it, let the dust settle and then let’s reevaluate. And really we were back offering non-QM loans 30, 40 days later [at the end of April, first of May].
Q: You came back in less than two months. But did everything come back?
A: I would say we’re 90 percent back. There are still some products that we need to wait and see where the economy goes, where the coronavirus goes and all that, but yeah we’re pretty close to where we were pre-covid.
Q: I suppose before we go any further we should explain what a non-QM loan is and who is a typical non-QM borrower.
A: Non-QM is really nonagency – FHA, Fannie, Freddie. If you don’t fit into one of those boxes, then the loans become a non-QM and funded by private investors. Certainly the self-employed borrower is the No. 1 non-QM borrower. They do not have credit issues but Fannie and Freddie, the agencies, they have one way of looking at income and that’s it. And if you own a business, your tax returns in many cases don’t reflect your ability to pay a mortgage. That’s what we’re looking at. Are they going to pay us back? We are able [to make these loans] because we are privately funded through private capital. We’re able to look at different ways of determining someone’s ability to repay.
That’s the biggest market but it’s other [borrowers]. Maybe it’s some people who have had some credit blemishes. You also have to remember that agencies use computers to approve or not approve a loan. They can’t work in an area of gray. It’s black or white.
Q: Jumbo loans are non-QM loans too, right? (Jumbo loans are mortgages above the limits set by the Federal Housing Finance Agency. In 2021, the limit is $548,250 for most markets and $822,375 in high-cost markets.)
A: Our average loan amount post-covid is over $500,000. Anyone who is above the agency loan limits is not going to qualify for an agency loan.
Q: Many readers may equate non-QM loans with the risky loans of the housing crisis. How are they different?
A: There are some really key difference-maker issues now. First and foremost, every single loan that was given in 2006 in the nonagency world was 100 percent financing so there was no money down. Today, our average down payment on every non-QM loan is over 20 percent. There’s a lot of other things, but that’s the biggest one. When someone comes to the closing table and writes a big check of their hard-earned money, they’re going to work really hard to pay their mortgage and not lose their home.
There’s also things like technology. We can confirm and verify things now that we couldn’t in 2006. We can find out a lot more about a borrower now that we maybe weren’t able to tell before. The mortgage business has a lot of technologies, fraud guards and things like that that just weren’t available.
Q: Nevertheless, we’re in the middle of a pandemic right now. Are you concerned about your loans? Like you said, you have no government backing on these loans.
A: I think there’s always got to be a little bit of concern, just about our entire economy and in the virus. Right now, I’d say the loans that were originated today, we’re looking at people and how they performed during the pandemic. So think about that. And let’s just say that, a majority of our loans are self-employed borrowers. We get to see their income stream during a pandemic. That was one of the things we always heard: Well, non-QM has never been stress tested. Well guess what? That’s no longer the case.
Q: Many lenders are at capacity because of low rates. A refinance is much easier to process than a tricky non-QM loan. Are lenders doing non-QM loans or are they too much work right now?
A: Our industry has learned over the years that building your business on a refi market is shallow. It’s going to crumble at some point. The good originators never take their eye off the purchase market and non-QM is a purchase market product. I would say you’re not going to get [non-QM loans] from the biggest of big lenders. But the mortgage brokers and the independent mortgage bankers, they participate in non-QM every single day. So I think the only thing that you would be ruled out of is maybe the online lenders.
Q: But will a non-QM borrower have to wait longer to get their loan? For example, if someone is borrowing $400,000 to buy a house and another person is borrowing $600,000 for a house, the borrower asking for the lower amount will get it quicker, right?
A: Actually, the opposite is true. Because the agency lenders are so backed up with the refinances, they are struggling to get purchase transactions done on time. Our average turn-time for non-QM loans from start to finish is under 25 business days.
Q: Where is the non-QM market headed in 2021?
A: We’ve always considered the non-QM market to be about 10 percent of the overall origination business. Now 2020 was a little odd because of the influx of refinances but in a normalized market that’s where we’re working toward. We’re not near that. We have so much growth opportunity. Certainly, you can’t underestimate the overarching economic factors and the pandemic factors. But in general, we feel like we’re back on track and the industry is back on track to make non-QM that 10 percent of the market that it will be at some point. We expect 2021 to be a huge year in the non-QM space.