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- Type 2: Temporary QM Loans. Loans that meet the “Temporary QM” definition must meet all of the same requirements as the General QM loans. Additionally, they must be eligible for purchase or guarantee by Fannie Mae or Freddie Mac. However, they are not subject to the 43% maximum DTI ratio threshold that applies to General QM loans.
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During the early days of the coronavirus recession, the market for non-qualified mortgages ground to a halt. In recent months, however, non-QM loans have returned as an option for self-employed borrowers who don't qualify for mainstream mortgages.
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'The industry obviously took a beating,' says Raymond Eshaghian, president of GreenBox Loans, a non-QM lender in Los Angeles. 'But in the last few months, we've seen that market bouncing back.'
Angel Oak Home Loans, a non-QM lender in Atlanta, reports a similar trend. Investors shunned non-QM loans in March and April as too risky. But with the housing market holding up well during this recession, mortgage investors — who dictate the availability of non-QM loans — have reversed course.
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'It's not back to full volume, but it's close,' says Mac Cregger, senior vice president and regional manager at Angel Oak.
What are non-QM mortgages?
Non-QM loans sport a jargony name that only a bureaucrat could love. The concept of qualified and non-qualified mortgages grew from the regulatory response to the housing crash.
When the mortgage market melted down in 2007 and 2008, the primary culprits were 'liar loans,' stated-income loans and other fast-and-loose mortgages that approved borrowers for risky debt. In the aftermath of that debacle, the Consumer Financial Protection Bureau in 2014 sought to marginalize exotic mortgages.
The QM rule requires lenders to offer loans with features that protect borrowers from mortgages they can't afford. There's still some wiggle room, though, and that's where non-QM loans come in.
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A borrower taking a loan that will be bought by Fannie Mae or Freddie Mac provides pay stubs, tax returns and bank statements as part of the approval process. A non-QM borrower, on the other hand, typically submits only bank statements.
Cregger points to quirks in the tax treatment of business expenses. To lower their tax bills, entrepreneurs use business expenses to offset their income. However, that practice might not make their tax returns attractive to lenders.
Cregger offers the example of the owner of a plumbing business — with his fleet of trucks and roster of employees, his tax return shows hefty expenses and not much profit. 'On paper, he may not look like the guy making $1 million,' Cregger says.
Instead of scrutinizing tax returns and pay stubs, non-QM lenders focus on borrowers' bank statements. As of mid-September, Angel Oak was offering bank-statement loans for as much as $3 million to borrowers with credit scores as low as 660.
A niche offering
One obvious downside to non-QM loans is their cost. At a time when rates on Fannie and Freddie loans are at record lows — below 3 percent — rates on these specialty mortgages are typically more than 5 percent. That explains why non-QM loans remain a niche product.
'When I talk about non-QM loans, I refer to them as less than 4.5 percent of all loans done in America,' says Logan Mohtashami, lead analyst for HousingWire.
Even if the market for non-QM loans is small, the mortgages play an important role, say proponents of non-QM loans. Before the coronavirus pandemic struck the U.S. in March, non-QM loans were the fastest-growing segment of the mortgage market, Angel Oak says.
With more and more Americans working as independent contractors, many borrowers struggle to get approved for qualified mortgages. 'There is a large percentage of loans that don't fit in that box,' Cregger says.
And the box seems to be getting smaller. In June, Fannie Mae and Freddie Mac, the government-backed companies that buy most of the mortgages issued in the U.S., began requiring additional paperwork from self-employed borrowers. The agencies want borrowers to provide year-to-date profit and loss statements that show revenues, expenses and net income so far in 2020.
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The Consumer Financial Protection Bureau announced Monday two notices of proposed rulemaking surrounding what’s commonly known as the QM Patch. One of those rulemakings would remove the debt-to-income requirement from qualified mortgages.
Back in January, CFPB Director Kathy Kraninger sent a letter to several prominent members of Congress, saying the bureau has decided to propose an amendment to the QM Rule that would “move away” from DTI as a factor in mortgage underwriting.
Specifically, Kraninger said at the time that the CFPB has decided to shift from the DTI standard and move to an “alternative, such as a pricing threshold (i.e., the difference between the loan’s annual percentage rate and the average prime offer rate for a comparable transaction.)”
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Now, Kraninger is following through on that plan.
In the first notice of proposed rulemaking, the bureau wants to amend the qualified mortgage definition in Regulation Z to replace the DTI limit with a price-based approach, saying it preliminarily concludes that a loan’s price, as measured by comparing a loan’s annual percentage rate to the average prime offer rate for a comparable transaction, is a more holistic and flexible measure of a consumer’s ability to repay than DTI alone.
For eligibility for QM status under the General QM definition, the bureau is proposing a price threshold for most loans as well as higher price thresholds for smaller loans, which is particularly important for manufactured housing and for minority consumers. The NPRM also proposes that lenders take into account a consumer’s income, debt and DTI ratio or residual income and verify the consumer’s income and debts.
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The Ability to Repay/Qualified Mortgage rule was enacted by the CFPB after the financial crisis and requires lenders to verify a borrower’s ability to repay the mortgage before lending them money. This includes a review of a borrower’s debts and assets to ensure they have the ability to repay the loan, with a stipulation that their DTI ratio does not exceed 43%.
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But Fannie Mae and Freddie Mac are not bound to this requirement, a condition known as the QM Patch. Under the QM Patch, loans sold to Fannie Mae or Freddie Mac are allowed to exceed to the 43% DTI ratio.
“The GSE patch’s expiration will facilitate a more transparent, level playing field that ultimately benefits consumers through promoting more vigorous competition in mortgage markets,” Kraninger said. “The bureau is proposing to replace the patch with a price-based approach to QM loans to preserve consumer access to mortgage loans while also making sure consumers have the ability to repay them. The bureau is committed to ensuring a smooth and orderly mortgage market throughout its consideration of these issues and any resulting transition away from the GSE Patch.”
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The QM Patch is due to expire in January 2021, and last year the CFPB moved to officially do away with the QM Patch on its stated expiration date, however the second notice of proposed rulemaking from the CFPB Monday would move that date to ensure a smooth transition.
The bureau proposed to amend Regulation Z to extend the QM Patch to expire upon the effective date of a final rule regarding the first notice’s proposed amendments to the General QM loan definition in Regulation Z.
“The bureau is proposing to take this action to ensure that responsible, affordable credit remains available to consumers who may be affected if the GSE Patch expires before the amendments take effect as defined in the first NPRM,” the CFPB stated.
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This could come as welcome news to the housing industry, which has long been calling for an end to the QM Patch.
“America’s Realtors applaud the CFPB’s action to provide a temporary QM patch extension, and commend the bureau and Director Kraninger for acting on behalf of our nation’s consumers and homebuyers at a time when market stability is so critical,” National Association of Realtors President Vince Malta said. “Perhaps most importantly, we appreciate the Bureau’s decision to eliminate a hard DTI standard, and we look forward to more closely examining the proposed replacements and their impact on homebuyers over the coming months.”