Mark Dodson was having a promising start to the year. His corner of the Atlanta mortgage market – high-value home loans that wouldn’t be bought by the GSEs – was booming.
At that point, Dodson was actively working on a jumbo loan for friends of his from church.
“I told my client, my friends, ‘Look, I know you’re supposed to close in 10 days but we’re closing Friday and you let everybody know it or you may not close,’” Dodson said. “And damn if we didn’t close Friday and they shut it down Monday.”
“I lost $6 million in April,” the broker added.
During the freeze, non-QM lenders – who issue mortgages that can’t be sold to Fannie Mae or Freddie Mac, typically to self-employed borrowers – stopped accepting applications, collectively laid off hundreds of workers; had difficult conversations with their investors, correspondent partners and mortgage brokers alike; and plotted an eventual return to an uncertain market.
Some firms quickly pivoted to conventional products to serve remaining customers. Others took stock of their product offerings and tech stacks and initiated strategies to build stronger companies in the wake of the pandemic. Over the last several months, liquidity has poured back into the non-QM market, prompting roughly a half-dozen lenders to once again underwrite non-QM loans.
“Pre-COVID, loans were trading at 103, 104, maybe even 105 [cents to the dollar], and the margins were there and it was a successful business,” said Keith Lind, the executive chairman and president of Citadel Servicing, one of the biggest non-QM lenders in the country. “The origination credit quality was very good. But when the credit markets seize up and liquidity stops, all of the sudden we went to maybe a low of 85 or 88 cents on the dollar. So when that happens, you don’t originate, you don’t lend at par for something at 88. So you stop.”
Everyone bowed out. Citadel’s competitors Angel Oak Mortgage Solutions, New Rez Mortgage, Caliber Home Loans, Athas Capital Group, Carrington Mortgage Services and First Guaranty Mortgage Company all halted issuing non-QM loans, which comprise roughly 5% of the overall mortgage market.
Though most of the sizable non-QM lenders have rehired staff, resumed lending or are on the cusp of doing so, they must still contend with a thorny problem: a good chunk of mortgage brokers are so awash in comparatively easy mortgages that they won’t bother with non-QM products, which are more complex and time-consuming than conforming mortgages.
“When Angel Oak Mortgage Solutions launched seven years ago, we had to educate [brokers] on the non-QM space,” said John Jeanmonod, a vice president at the Atlanta-based non-QM lender. “Now we’re educating them on why there was a pause. Most of them know why, but all of them really just want to know, ‘How are you going to try and close my customer today?’”
He added: “What we’re really trying to tell them now, almost more than ever, is that the self-employed borrower hasn’t gone away. And whether you do it or someone else does it, that loan is going to get done.”
This ain’t your daddy’s subprime
About a decade ago, mortgages that were ineligible to be bought by Fannie and Freddie were tagged with the odious label “subprime.” Such mortgages, infamous for atrocious credit standards and a lack of skin in the game on the part of borrowers, ushered in a collapse of the housing market, which triggered the Great Recession of 2008.
Loans that don’t meet the GSEs’ standard today are known as non-QM, but few observers believe there are parallels to what happened 12 years ago. Lenders today have more rigorous standards on non-QM products, and forbearance rates roughly are in line with agency loans. As is true with loans sold to Fannie and Freddie, non-QM lenders must ensure the borrower can pay back the loan and is credit-worthy. But unlike Fannie and Freddie, most non-QM loans rely on the borrower’s credit score and the loan-to-value ratio on the loan, rather than the debt-to-income ratio.
The products appeal mostly to independent contractors and self-employed borrowers, with non-QM lenders often marketing their wares to real estate agents who have entrepreneurs for clients.
“Self-employed borrowers take advantage of the tax laws,” said Dodson, who runs Mortgage Capital Advisors. “For eight years they were not able to get a mortgage loan – they could have an 800 credit score, $2 million in the bank. But they were still hampered because lenders wouldn’t give them a loan. That’s when we get ‘em. I’m also finding that self-employed people know a lot of self-employed people. It’s about getting word out to them. Realtors need to be your ally.”
There’s a common misconception that because the products aren’t guaranteed by the federal government, they’re marred by sloppy underwriting or exorbitant risk, mortgage executives and brokers said.
“It was just a liquidity issue,” said Angel Oak’s Jeanmonod of the tremors in the spring. “Everyone gets the non-QM sorely confused with what happened during the mortgage meltdown…our underwriters are the best in the business. ”
Angel Oak relaunched in May with a pared back set of products and tightened down payment requirements. Since May, they’ve had 19 enhancements to their programs due to renewed liquidity. “We still don’t have all the programs back yet,” Jeanmonod said. “We have the bank statement program, jumbo loans. It wasn’t that borrowers weren’t performing, it was that the investors didn’t have a broad appetite.”
Citadel has also returned with a streamlined list of products. It now does three-month bank statements as opposed to one month, and requires higher levels in reserves.
Since the market has returned, borrowers with sizable reserves and strong credit histories are typically finding interest rates in the 5% and 6% range, said Yonce.
The path of least resistance
Though the non-QM lenders are frustrated by a reluctance on the part of some brokers to push their products, they understand the dynamic at play: it’s the path of least resistance, and the non-QM reputation perhaps doesn’t live up to its underwriting quality.
Most mortgage brokers would rather collect 100 bps a pop on simple refinancing deals that take a few weeks than a non-QM product that takes at least twice as long to close, non-QM executives said.
“It’s not the borrowers, it’s the fact that the brokers aren’t focusing on non-QM,” said Lind. “They’re going to the low-hanging fruit, the agency product because they’re probably making more money. But I think we’ve done a very good job – we’re extremely efficient, return times are fantastic and if you give us a non-QM loan we’re going to close it.”
One broker said abandoning agency loans in favor of non-QM product in the current environment simply didn’t make business sense right now.
“I wouldn’t chase that business because I have 46 loans in process that are fairly simple to do,” said Matt Gougé, a broker at Answer Home Loans in Folsom, California. “And non-QM loans in my experience are harder.”
Yonce, who runs Dallas-based Greater Texas Mortgage, said the non-QM space still has to work on its perception in the marketplace.
“Newer loan officers are scared of the business because they think it has to do with predatory lending,” said Yonce. “And it doesn’t. It’s the total opposite from that. They don’t understand it, so they can’t sell it to the customer.”
Jeanmonod and Lind both noted that brokers will be more conscious of the non-QM market when rates fall and the refi business slows.
“There are people out there who are just focusing on refis, and when those go away that LO is in jeopardy of losing income,” said Jeanmonod. “Like anything, you have that seasoned loan officer who has a stream of referral sources whether it’s a Realtor, CPA, bankruptcy attorney, etc. they hopefully cherish that referral source and work on all loans equally.”
The ups and downs of the non-QM market over the past calendar year has led to a flurry of referral activity. Loan originators at retail banks pushed non-QM deals to specialist brokers like Dodson and Yonce, they said.
Dodson said he had a client who recently made a $1.8 million purchase after he was turned down by a retail bank. The client had adequate reserves, a great credit score and two years of bank statements to determine income. Angel Oak funded the loan.
“He was thrilled he had an option of buying this house when he didn’t have one two days earlier,” said Dodson. “In this case, the banker referred him to us.”
Business is “not quite there yet“
Though the lenders and brokers are back cranking loans and investors are comfortable with non-QM products, they’re still not quite firing on all cylinders like they had been in January.
In January, non-QM loans were arguably the hottest product on the mortgage market and were on a high not seen since 2007. They were performing better than FHA and conventional loans, said Yonce. Then COVID hit.
“So at that point, it was really strong – I was averaging probably at least three bank statement loans a month,” said Yonce. “And then when COVID hit, they went away overnight.”
But lenders and brokers are both optimistic that business will return to normal levels in 2021.
“We started originating in August, we funded our first loan in September. I think we’ll be back to our pre-COVID levels hopefully by early spring,” said Citadel’s Lind. “Pre-COVID, 65% of our business was cash-out, now 70% of our business is purchase. I think rates up in the agency market is going to be very humbling…and there will be a lot of tailwinds for the non-QM work.”
“We’re not there yet,” added Dodson. “We were killing it with the non-QM. The higher loan-to-value loans aren’t back yet but we got 90% bank statement deals back and that’s a big, big product.”
Jeanmonod, who’s based in Dallas, said Angel Oak is about 50% back to normal levels (they originated about $3.3 billion in mortgages in 2019). “We’re probably about halfway back and increasing every month,” he said. “Our month-over-month growth has been outstanding. It’s going to hockey stick back.”
James Kleimann is the mortgage editor at HousingWire. Email him at email@example.com