A return on the horizon for alternative loan products is inevitable. While the products associated with this category have all but vanished, a new type of borrower is emerging that will reshape how loans that don’t fit the traditional 30-year-fixed model are fashioned.
Single family loans originated in 2010 and 2011 has proven to be the most solidly underwritten loans in years according to recent data from LPS. While lenders’ conservative credit standards have been vilified as excluding many potential buyers from the market, the upside is that high quality mortgages are being originated by lenders, and eventually purchased by GSEs.
From the lender perspective, this could indicate no need for subprime, Alt-A, or other types of “exotic” loans which were considered to be the root cause of the mortgage meltdown. The issue with these products was that their underwriting standards weren’t based in reality. The predominance of these vehicles in the market was driven by lender/mortgage broker misuse, by marketing securities based on pools of mortgages with these shaky underwriting yet high returns, by appraisers being aware of the value needed for the loan to happen, and by poor oversight by government entities that guaranteed these products. As a result, poor loan quality destined for default was a defining element of this product set.
Stricter underwriting and scrutiny by regulators made subprime and Alt-A products virtually extinct and made borrowers with strong credit, deep reserves, and positive equity in existing properties the perfect borrower scenario for lenders. But now, the pendulum has swung the other way; qualified buyers who don’t meet these criteria are left in the cold and risk-averse lenders have taken the position that it is better to hold off on lending except in a perfect borrower scenario.
The need exists, however, to service this class of borrower. New regulations governing our current lending environment, combined with more responsible lending practices, should provide the necessary restraints to prevent the credit misuse characteristic of alternative loan products seen in the last lending cycle.
Regulations requiring appraisals independence from broker shops, the end of yield-spread premium bonuses paid by lenders to brokers, and more upfront consumer disclosures are examples of current practices which should mitigate the risks of inflating home values and stop predatory marketing of non-traditional loan products to unqualified borrowers characteristic of the past real estate boom. Moreover, the mortgage industry has taken a much more responsible stance toward to who it lends money.
The end result of these factors is twofold: home values are substantiated and grounded in fair market value, and buyers will be vetted by a clear ability to afford the purchase price. As the market stabilizes, more lenders should then feel comfortable originating loans at higher loan-to-value ratios, relaxing FICO criteria, or eventually streamlining documentation requirements for qualified buyers.
“Qualified buyers” is of course, a moving target as the housing market regains its confidence and equilibrium. But the class of qualified buyer is sure to grow past what the standard conforming 30-year loan model can accommodate. Lenders will need to relax some standards and offer new or better monitored “old” products to fill the void.