It took more than three years for 2005 vintage subprime loans to get the kibosh.
The Federal Reserve didn’t change the Truth-in-Lending Act until 2008, allowing zero-down, middle FICO under 600, prepayment penalties, balloon payments and liar loans (no supporting documentation required) to flourish.
By requiring a reasonable determination of a borrower’s ability to repay, the Fed put an end to toxic mortgages as we knew them.
Fast forward to 2014 when a more tasteful version of subprime mortgages emerged.
Named non-QM or non-qualified mortgages or non-traditional mortgages, a borrower needed as little as 10% down, 12 months of bank statement deposits in lieu of hard tax returns to show income, and in some cases a minimum 660 middle FICO score.
Other programs allowed borrowers to leave the income and employment sections blank. And, for rentals, if you collected a dollar more than your interest-only mortgage payment, you got approved.
It took exactly one week for this 2014 vintage of exotic mortgages to crash and burn.
By Tuesday, March 24, the entire category of non-QM loans was on meltdown. Lenders refused to fund purchases and refinances that were in the queue. A plethora of employees in this space are losing their jobs as we speak.
This time, the market drove this shutdown, not the Federal Reserve.
Non-QM investors (those who purchase mortgages from lenders as interest-earning investments) got spooked from the crushing wave of economic calamity triggered by the novel coronavirus.
How can these more loosely underwritten mortgages possibly perform well, or at all, when the economy has been absolutely decimated?
Non-QM mortgages accounted for only 2% of the $2.3 trillion in mortgage funding in 2019, according to Guy Cecala, CEO and publisher of Inside Mortgage Finance. He and others confirmed that the non-QM production was heavily weighted in California due to the larger loan sizes and the large number of non-QM lenders based here.
Warehouse lenders are the new sheriff in town.
Mortgage lenders borrow funds through massive lines-of-credit or warehouse lines. When investors wire funds to lenders to purchase already funded mortgages, warehouse funds get replenished.
It’s like when you use your credit card to buy goods and then write a check to your credit card company on your payment due date.
Many non-QM lenders have loans sitting on their warehouse lines for which there are no buyers.
Warehouse lenders don’t want to get stuck with potentially non-performing loans. If a borrower loses his or her job before an investor purchases a loan, that loan will get stuck on the warehouse line.
Warehouse lenders have a whole arsenal of contractual ways to force the lenders to get the mortgages off what are supposed to be temporary credit lines. This will not end well for any of these stakeholders.
One key warehouse lending executive explained to me they now are looking at their risk when allowing even regular mortgages (Fannie, Freddie, FHA, VA and jumbo) to be funded for non-essential workers in battered industries like the airlines.
“Buyers cancel. Refinance borrowers close their loans whether they have a job or lose their job” or are about to lose their job, he said. “We are not in the business of risk.”
The executive explained the mortgage lender can take the borrower all the way to funding. But before funding, the warehouse lender has the contractual right to consider the entire credit package and has authority to reject funding.
If you are thinking about purchasing or refinancing a property, think hard about what you might write down to defend your viability at your job and the continuality of your current income stream.
Dig out your most recent two months of bank, stock and retirement statements to show your depth of cash reserves and sustainability. Start thinking about how you would approach your boss for a letter assuring you are a key employee, or dust off your recent five-star employee evaluation.
If you are working at Walmart, Walgreens or Ralphs grocery store, you are essential. If you are in car sales, not so much.
Let’s be clear. Apply for your mortgage if you are in want or need. And, do it sooner rather than later. We don’t know how long this economic volatility is going to last. But, the longer it lasts, the harder your credit package is going to be looked at.
Jeff Lazerson - Mortgage Columnist since 2011