As the number of prime borrowers dries up, investors are showing an increased appetite for non-prime loans, which are markedly different from the subprime lending that was a hallmark of the financial crisis.
Today’s non-prime loans are carefully underwritten with an appropriate examination of the underlying collateral. These loans serve borrowers who have been unable to qualify for government-backed loans, but may otherwise have good incomes and room for substantial down payments.
By opening up a whole new category of borrowers, non-prime loans provide a lucrative new avenue for both lenders and investors.
Citadel Servicing Corp. (CSC) was the first company to offer non-prime loans in late 2012 after the crisis and is using its expertise in underwriting to offer products to an underserved population, expanding the number of potential borrowers for mortgage brokers. CSC’s Outside Dodd-Frank (ODF) Program includes foreign national loans, business use, and non-owner-occupied loans.
To qualify for CSC’s Foreign National Program, borrowers only need to provide a passport and a letter of good standing with a financial institution.
“Most institutions ask for income documentation, but what does the proper documentation from China or Russia look like, and how can we really verify them?” asked Will Fisher, senior vice president of loan production, sales and marketing at Citadel. “The max LTV on this loan is 70%. Because of the LTV restrictions we impose on ourselves, we’re comfortable with what we’re lending.”
This unique loan product allows for borrowers to buy second homes and non-owner occupied properties of one to four units.
“This loan is very popular for properties on the coasts, which you would expect: Florida, the Bay Area, tech areas. But it’s slowly becoming more prevalent throughout the United States,” said Fisher. “And these borrowers aren’t coming from one particular country either; they’re from all over the globe.”
The Non-Owner Business Purpose Loan features no TRID disclosure requirements, no income requirements and no reserve, asset or DSCR requirements. These loans also have no pre-pay penalties or charges for lender points, unlike many loan products of this genre.
“What really separates us with this product is the elimination of the pre-payment penalty, lack of lender points and lower rates than hard money. Additionally, our loans are 30 years amortized, 5/1 or 7/1 ARMs,” Fisher said.
“Right now, we are seeing a few prime lenders entering this space,” said Fisher. “However, most of these new entrants are allowing borrowers with 550 credit scores and lower to borrow 95% and more on the value of a home, through FHA programs. We view this as extremely risky and borderline irresponsible. I think these prime lenders are in for a big surprise if they try to get away with 8-10% delinquency on an asset class not backed by the GSEs.”
“To that point, most of these new-entrant prime lenders are only pass through lenders when it comes to non-prime,” said Fisher. “They are relying on their big brother to give them prior approval so they don’t wreck the proverbial car!”
When it comes to risk, CSC’s underwriting process carefully calculates how and when to layer risk, resulting in loans that are performing better than those backed by FHA. While the government investors are experiencing default rates of 8-10%, CSC’s delinquencies are below 3.5%.
“We underwrite all of these loans by hand. It may take slightly longer but we have a better understanding of who we are lending to and that lets us make exceptions when we need to,” Fisher said.
And CSC services its own loans, which allows us to better understand what works and doesn’t work, then we can adjust our underwriting strategy accordingly.
“We are at the intersection of an increasing rate environment, with increasing access to capital, and non-prime is at the center of that,” Fisher said. “Given the increase in demand, our data confirms there is easily $100 billion, if not more, of this paper out there this year alone., We’ve been experiencing month-over-month growth for the last five years.
“There needs to be a realm between pure hard money and prime lending, and non-prime fits that niche.”