REI INK

A Q&A with Thomas Price

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Deciphering the Complexities of Insurance for Investors, Lenders and Agents When real estate investors secure mortgages for a portfolio of properties, the complexity of their insurance needs may be more than they bargained for. In a changing real estate environment, it has become more challenging to anticipate and cover common risks. Their mortgage lenders, too, often need help untangling the nuances. What should both parties know? REI INK asked Thomas Price, President, Incenter Insurance Solutions, for his insights. Why has insurance coverage become such a complicated issue for real estate investors and lenders? When investors have a portfolio of income properties such as single-family and multifamily rentals, then they need commercial property insurance, which is inherently more complex than residential insurance for individual homeowners. This is due to the greater number of properties involved, their varying locations, and differing state and municipal regulations. Moreover, new risks such as floods, intense storms, supply chain interruptions, and a volatile economy can also make a larger impact, proportionately, on these commercial portfolios. It is not just real estate investors who need to navigate this maze. Their mortgage lenders and insurance agents are continually addressing the complexities, too, and every party has a different outlook and priorities. Could you explain this disparity? Real estate investors understand the importance of insurance, but they have operating margins to maintain. They may see insurance as a cost center that reduces their yields and need education on how a changing risk environment should be prompting a more careful look at their policies. Lenders’ focus, on the other hand, is on market value—both from the origination and trading sides. The amount they have available to lend—and the value that they need to protect—will vary with the direction of the real estate market. The ultimate ownership of these loans is another critical consideration for lenders. If they plan to raise cash by selling portfolios to the secondary market, then every property must have appropriate insurance. Otherwise, lenders could be in violation of their investor covenants, and the financial consequences could be devastating. Insurance agents bring a third perspective to the party—focusing on properties’ insured value, which could be affected by depreciation, geographical location, and a host of other variables. All these different worldviews need to be reconciled. How easy is it to do this? It can be very challenging, especially during periods of heightened investor activity. In February 2022, for example, 28% of all single-family home purchases were made by real estate investors. Lenders, wanting to streamline and speed these transactions, are hard pressed to keep up with the “usual” title, appraisal and related details. They are not insurance experts and may miss a nuance that they will have to deal with after the fact—when they are attempting to securitize and trade these assets. Investors and their insurance agents, too, will push ahead in a competitive marketplace with their own objectives front and center. Limited inventory and competition from new market players, such as Millennials who have turned into “laptop landlords” (Wall Street Journal), could propel investors to value speed and agility while skipping over some of the finer coverage details. It is important for all parties to step back and assess the new or heightened risks that could reduce their yields in this evolving world. As you are interviewing me, for example, I am reading about a major flood that we might not have fathomed just a few short years ago. Now everyone must anticipate these increasingly common scenarios. When a lender uncovers a potential insurance gap, and investors and their agents are alerted, getting all parties onto the same page can be painstaking—but it is worth it in the long run. What kinds of coverage should all parties be reviewing? They should be reviewing all property and casualty coverage to ensure that it is sufficiently comprehensive. There are three general categories:  »         Basic peril, which names exactly what a policy will cover, such as ice, tree damage, and theft. Perils that fall outside of this list will be excluded.  »         Broad peril, which covers a larger group of risks, such as accidental water damage or frozen pipes that burst.  »         Special “blanket” form insurance which accounts for an even broader list, but still excludes specific risks—ranging from war and terrorism to floods and named storms. Lenders tend to scrutinize this coverage and may want investors to supplement it with additional policies. What about valuing potential losses? What are the considerations here? This is where discussions can become especially complicated. To begin with, there are several values that may be more or less important to the parties involved, including:  »         Actual cash value, or what a property is currently worth.  »         Replacement cost to make a property equivalent to what it was before.  »         Market value, which is determined by an appraisal professional.  »         The loan value, or the mortgage that the investor received.  »         Insured value, or how much insurance the property owner has taken out. For example, some lenders might require that investors’ insurance only cover the value of their original loan. In other cases, they may want these investors to be covered for full replacement costs. These lender requirements can lead to issues that should also be addressed upfront. For instance, consider a lender that values properties for insurance purposes by their replacement costs. An investor borrows $450,000 from that lender for a single-family rental, which burns to the ground before it has been refurbished for tenants. Though they would like a $450,000 check from their insurance company, the actual replacement costs are $300,000, so reimbursement will be limited to that amount. To avoid—or at least anticipate—these situations, all parties should be reviewing the insurance on commercial portfolios every year. In today’s investment market, the benefit of protecting lenders’ and investors’ assets, even when potential risks materialize, is too promising to ignore. Thomas Price is President of Incenter Insurance Solutions. The organization’s Lender Insurance Services include real estate investment portfolio reviews of existing insurance, and

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Gainesville, Florida

This Hotbed of Growth Needs Real Estate Solutions By Carole VanSickle Ellis In June of this year, Gainesville, Florida’s home prices were on their way up, much as they have been for the last decade. However, this past June’s median sale price of $365,000 was a far cry from a decade earlier when median homes sales were less than one-third of today’s price tag. Alachua County, which contains the majority of the Gainesville metro area, has been a popular market for real estate investors for years due to the inherent benefits of investing in the southeastern United States, in general, and in the state of Florida, in particular. The combination of low cost-of-living expenses, no state income tax, low sales tax rates, and an extremely temperate climate have created a demand for Florida housing for decades. With the advent of the COVID-19 pandemic, housing demand skyrocketed. Even with many companies partially or entirely abandoning remote work practices in 2022 and calling employees back to offices in larger metro areas, that demand continues to create a white-hot market in central Florida as well as on the coastlines. Gainesville, with its central location (two hours of driving from Orlando and Jacksonville), the local presence of the University of Florida, and its position in the north central region of the Florida High Tech Corridor, is set to remain a market where housing demand is high and availability is scarce for the foreseeable future. “For every home based on a [given] price point, you will have possibly 10 buyers that want that home,” observed one local agent in May of this year. She noted that listings had plummeted to only about a fifth of the volume the area has seen in previous years. Although listing volumes have risen slightly since Spring 2022, rising interest rates will likely keep many buyers out of the market, keeping competition fierce even if the bidding wars involve three or five buyers instead of 10. Realtor.com analysts still rate the Gainesville market as a clear sellers’ market, noting that at the end of the summer, homes were on the market only 49 days. However, investors should note that homes are selling slightly below list price. In August, the median list price was $320,000, while median sales prices were just under $290,000. Given that the national median home price exceeded $440,000 midway through this year, however, demand in Gainesville is unlikely to ease to the point that prices will fall in the near future. A strong demand for housing from multiple, distinct populations of residents and ongoing scarcity issues have created an environment in Gainesville where fix-and-flip investors are thriving. While much of the rest of the country has posted falling returns for fix-and-flip deals, Gainesville flipping rates are still high. In fact, nearly one-sixth of all transactions are flips, according to ATTOM Data’s Q1 2022 “U.S. Home Flipping Report,” and cash buyers have a distinct advantage. “As interest rates continue to go up, cash buyers should be in an even greater position of competitive advantage in the fix-and-flip market,” wrote ATTOM Data executive vice president of market intelligence Rick Sharga. He added that investors with “larger, better capitalized” businesses could begin to increase their activities in the coming months. In the category of markets with a population of less than 1 million, only Durham, North Carolina, had higher flip rates than Gainesville. As of August 2022, available inventory was still falling, with 5.6% fewer homes for sale in the area than there were in July. While interest rates may be decreasing the volume of competition for properties, those still in the thick of things are highly competitive. A Prime Location for Education & Tech Gainesville is not necessarily the first market most investors might think of when they think of the sunny state of Florida. It is located in the northern, central part of Florida, without beach access (although Flagler Beach is about 90 minutes away, which places the city solidly in the “beach-proximal” category so important to many COVID-fueled moves), and about two hours from Disney World. However, Gainesville is home to the University of Florida and a clear landmark on the Florida High Tech Corridor, a 23-county region anchored by three of the largest research institutions in the country: the University of Central Florida (UCF), the University of South Florida (USF), and the University of Florida (UF). Of those three, Gainesville’s hometown university, the University of Florida, is ranked fifth on the U.S. News & World Report list of best public universities in the country, boasts an on-site student population of roughly 75,000, and is highly affordable. The Florida High-Tech Corridor was founded by the Florida legislature in 1996 as an economic development project intended to attract and retain technology companies. At that time, several companies in residence in the state were being actively courted by other states and even countries. The corridor was originally conceived as part of a larger plan to incentivize existing companies to reinvest in the area rather than relocate and to also bring in new tech companies from other areas. Gainesville’s University of Florida has served as a full partner and co-chair on the Florida High Tech Corridor Council since 2005. The institution also plays an active role in chairing and supporting the growth of related initiatives including grant-matching programs, STEM programs that connect students with experts in industry and help the state retain young, professional talent, and a variety of magnet programs in the Gainesville area centered around the life-sciences industry and artificial intelligence innovation. Gainesville has benefitted from the corridor and UF’s position as an anchor in its development both directly and indirectly. There are many nonprofits dedicated to innovation and business incubation now located in the Gainesville area, while the university itself prioritizes workforce development programs that create and sustain valuable jobs in sectors known for creating more employment and lasting opportunities. At time of writing, UF had recently made headlines for surpassing $1 billion in research spending

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Market Predictions for 2023

While Not Rosy, Still Fair Share of Opportunities Ahead By Erica LaCentra As we head into the fourth quarter of 2022, predictions for what the real estate and housing market will look like in the coming year are pouring in. As mortgage rates continue to rise due to interest rate hikes by the U.S. Federal Reserve as a means of combating inflation, the general consensus across the industry is that we must deal with the reality that the housing market is in decline and will likely get worse in 2023 before it gets better. Does this mean we are in for a housing market crash similar to what the industry experienced in 2006? That seems like a very unlikely reality, and thankfully, a dramatic price crash and subsequent financial crisis do not appear to be in the cards. However, the changes that we are likely to see in the market will be substantial for both homebuyers and investors alike. So, let’s dig into the major predictions for the housing market for 2023, and ultimately how to prepare for any fallout they may cause. The Future of Home Prices Two of the biggest ongoing. questions on anyone in real estate’s mind are will home prices finally go down in 2023, and if so, by how much? Since the pandemic, home prices skyrocketed due to housing supply shortages and historically low-interest rates with many outlets quoting that home prices are up 40% since just March of 2020. Even as we approached the halfway point of 2022, home price growth had not shown much sign of slowing down. According to the CoreLogic Home Price Index, “national home prices increased 18.3% in June 2022 compared to a year ago. This growth followed the highest 12-month increase in the U.S. index since the series began in 1976 when April saw prices jump 20.3%.” It does look like prices are finally starting to cool down and that is predicted to continue into 2023. And it will be at a very slow pace. According to forecasts by Fannie Mae, it will not be until “the end of 2023 when home inflation returns to the 5% pace seen before the pandemic.” And even then, it seems like the baseline for U.S. home prices which we have seen set over the last few years, are likely here to stay. Fannie Mae is further forecasting that the median price of a previously owned home will surpass $400k by the end of 2023 and the median price of a new home will end at a record high of $464k by the end of the year, about $100k more than where the price of a new home sat in 2021. All of this calls into question issues of affordability for homeowners, which has been an ongoing problem since the pandemic hit. Those individuals that have been waiting for the right time to buy a home will likely be in for a mixed bag in 2023, with a better opportunity to find a property, as long as they have the means to afford it. Predictions for Housing Supply Another major topic on everyone’s mind as we look towards 2023, is will housing supply potentially start to improve with the market cooling. With home prices not likely to drop significantly in the near future and interest rates rising, many are hoping that this will finally provide a window for more inventory to potentially come on the market, or at least allow inventory to stay on the market for slightly longer to allow buyers a better opportunity as buyer demand remains strong. While there is the expectation that more inventory will be coming onto the market, there is the concern that homeowners will be less likely to list their homes for the remainder of 2022 into the new year, and we are already starting to see those concerns come to fruition. According to one of Redfin’s latest reports, “new listings of homes for sale were down 20% from a year earlier, the largest decline since May 2020.” So, the flood of inventory that homebuyers have been hoping for is still not likely, and any inventory that does come on the market is still not nearly enough to be able to put a dent in the supply issues that have been long-standing in the real estate market. Another area of concern when it comes to supply is the low level of housing starts in the U.S. that is not showing significant signs of improvement. Ongoing issues with material costs and labor have negatively affected this area of the market throughout the pandemic and this trend looks like it will potentially continue into 2023. Even with the construction sector experiencing an unexpected jump in August for both single-family and multifamily starts, with single-family starts growing 3.4% month-over-month and multifamily starts growing 28% month-over-month, housing starts overall are still struggling to meet demand. The single-family space specifically continues to be an area of concern when it comes to supply versus demand with weak builder sentiment and a 15.3% year-over-year decline in permits that a small jump cannot even hope to make a dent in. Unfortunately, according to the U.S. Census Bureau and the U.S. Department of Housing and Urban Development “total building permits fell by 10% in August with single-family permits down 3.5% and multifamily dropping by 17.9%.” So, while the increase in starts in August was nice to see compared to the sad streak of declines earlier in the year, the drop in permitting likely spells trouble on the horizon as it is a clear indicator that builders are likely slowing down potentially as they see the housing market starting to slow overall. This spells trouble for inventory levels going into the new year as new construction is crucial to meet future market demand. A Seller’s Market or a Buyer’s Market Based on the predictions we are seeing around home prices and housing supply levels, the final question many in the industry are asking is, will

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Investing in the American Dream

Residential Capital Partners (ResCap) Champions the Individual Investor By Carole VanSickle Ellis The founders of Residential Capital Partners (ResCap) knew a lot about real estate before they started working together and founded ResCap in 2009 in the midst of the U.S. housing crash and subsequent global financial meltdown. Each of the four founders, Paul Jackson, president and CEO of the company, Richard Morgan, chief investment officer at ResCap, and Greg England and Rob Feito, both directors at the private lending firm, have years of personal experience in real estate investing and a deep appreciation for the creativity and drive of the individual real estate investor. However, they initially planned to put their cumulative knowledge to use in a very different fashion by buying bulk packages of distressed mortgages rather than by specializing in making loans on single-family residential properties to individual investors. The tipping point occurred when the four principals realized many investors would not make it through the crash without a credit solution that was very hard to come by at that time. “In 2009, every investor out there was trying to figure out if they were going to have to reinvent themselves and their business or if they would be able to ride out the storm,” Jackson recalled. “The four of us had originally intended to function as a distressed-mortgage purchaser, but we pivoted in response to what we learned through our due diligence. The single-family rental investor was having a hard time finding credit in the market due to the global financial meltdown. With so many banks and other lenders sitting on the sidelines, we decided to tailor a credit solution for single-family residential investors.” The result of that about-face was Residential Capital Partners, usually shortened to ResCap, named to make the company’s mission crystal clear. “We saw a void of credit in the single-family rental investment space and decided to try to fill it,” Jackson explained. “Then, we all survived together. That resilience is one of the things we are most proud of: entering during the global financial crisis, being active during turbulent times, staying in business and staying open during the COVID-19 crisis, and building such important relationships over the last 12 years.” Morgan agreed. “We had all been actively involved in real estate before coming together as a firm, so we knew that single-family assets through four-unit assets would be a good fit for us with this enterprise. We have certainly been successful and enjoyed it — and our borrowers have been successful, too.” Everyone at ResCap enjoys the firm’s success stories most of all, naturally, but they do not define “success” by their own bottom line. Instead, they like to define it as helping investors stay in business when times get tough. Jackson told the story of a client in Chicago who had been funded primarily by a family office prior to the housing crash in the mid-2000s. Then, Jackson said, “his lender basically evaporated on him” due to the global financial crisis. By the time that investor found ResCap, he was in full panic mode. “He thought he was going to lose the business he had worked decades to build,” Jackson said. “We were able to work with him on the scale at which he was already operating. Instead of losing everything, he is still going strong.” Working in Partnership with Investors for Long-Term Success When a potential client comes to ResCap, they are immediately more than simply numbers on a page; they are the sum of a complicated, insightful blend of factors that ResCap uses to determine the viability of a loan and how much the firm will lend. In some cases, borrowers may be offered up to 100% financing for short-term rehab projects or for rental bridge loans, and ResCap also may fund up to 75% of the after-repair value (ARV). In addition to short-term bridge loans and fix-and-flip lending, the company also has adopted long-term financing catering to single-family rental investors. ResCap can adjust and adapt to its clients’ needs in large part because it is a balance-sheet lender and does not rely on a third party to purchase loans once they are made. “We assume the full risk of every loan we write and carry it on our books until it is paid off,” said Morgan. “Our success depends entirely on the success of our borrowers, so we make it a point to make solid decisions based on years and years of experience in real estate as well as more ‘traditional’ considerations.” “We are more than 100 years deep in experience on our bench of partners,” Jackson added. “We want our borrowers to have that kind of successful, long-term experience as well.” Once the borrower contacts ResCap about a loan, the team swings into action, learning more about the deal itself and, in addition, the strength of the borrower. Deals that are too “thin,” meaning the time and money invested will not likely create positive returns when the property sells, generally do not pass the ResCap test because, as Jackson puts it, “We want to do business with you, but some deals are just not rich enough for you to spend your time and energy trying to make money on them.” Morgan added, “It is really about making just one loan at a time. We have built a fantastic portfolio of loans one loan at a time, and we are committed to coming in every day, mastering the basics, and being really good at what we do so our borrowers can be really good at what they do.” The team also keeps a watch out for investors who are spread too thin. “From our perspective, the customer is part of the team,” Jackson explained. “Our number-one goal is to take care of them so that they can achieve their goals and the success they want in this space.” In today’s market, ResCap places an especially high priority on monitoring borrowers’ liquidity. That, Jackson said, is part of

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WHY Fix-and-Flip Investments?

Bottom Line: Profits Will Be Easier to Claim By Dalton Elliott One of the biggest surprise movie hits of the year has been “Everything EverywhereAll at Once.” That phrase does not just make a compelling movie title, but it describes how the economy and housing market is changing now. What’s changed? Interest rates. Rent rates. Available inventory. Customer demand. Home price appreciation. And more. A lot more. So, what has changed? Basically, it’s everything, everywhere, all at once. We are in the midst of a radically different housing market than we saw just 9-12 months ago. But that does not mean that real estate investors should panic. Opportunities still abound in the markets as it stands today. These opportunities are just different than they have been the past two years, and savvy investors will adjust their strategies to ensure profits amidst the change. From mid-2020 through 2021 to the first quarter of 2022, investors experienced a market almost perfectly designed for rental portfolio accumulation. Interest rates were at all-time lows and customer demand shifted from apartment living in high-density areas toward single-family living in suburban areas. So, it is no wonder that real estate investors—from mom-and-pop types to Wall Street investment firms—tried to pile up as many properties as they could through purchases as well as build-to-rent developments. But starting with the Fed’s move on interest rates in March 2022, the real estate market started moving quickly. Now that we are six months or so past that initial interest rate shock, there is more clarity about how these changes are shaking out. Here are three takeaways that show why pivoting to a fix-and-flip investment focus can help investors succeed in today’s market. 1. Increasing Interest Rates Will Soon Outpace Rental Rate Growth We do not yet know when the Fed will decide enough is enough with interest rates, but it is clear that it will be a while before the Fed cuts rates. This means that building rental portfolios will be more expensive. Continuing to build portfolios has been sustainable for investors so far in 2022 because rent rates have also grown (as stats from John Burns and Zumper indicate). But we are now seeing rents start to peak in some major markets, which means future interest rate hikes will make cash-flow margins much tighter for SFR landlords. Investors who have portfolio financing locked in at low rates will see profits continue to flow. However, in the short term, it is going to be much more difficult to leverage equity in a portfolio to buy more properties that will cash flow. Consequently, investors need to be rock-solid on their numbers and have a trusted financing partner if they want to add rental properties with confidence. One option to mention is bridge financing. Interest-only short-term loans can allow investors to purchase properties quickly while pushing off long-term rate locks for a year or two. In an increasing rate environment, this is one way to add to rental portfolios while maintaining cash flow in the moment. 2. Demand Still Outpaces Inventory The current housing market still features a significant inventory shortage, which means that demand outpaces supply. Median days on market (measured by St. Louis FRED) still lies at about a month and a half, well below the pre-COVID norms of 70-80 days. This inventory gap is one reason behind the significant increase in home prices over the past two years (17.7% YOY appreciation two years running, as measured by the FHFA). While prices have peaked in most markets, demand still exists for homes and rentals. Real estate investors can be confident that demand is there for properties they put up for sale. While investors may not get the market max prices that early 2022 boasted, they will still be able to recoup cash far above home values even two years ago. Investors can complete fix-and-flips or new builds with confidence, knowing that properties are not likely to sit on the market unsold for a long period of time. 3. Distressed Investment Properties Should (Slowly) Become Easier to Find While inventory is tight, some of the artificial constructs that have kept properties from becoming distressed are disappearing. Eviction and foreclosure moratoria instituted during COVID have now expired just about everywhere. And with interest rates rising, some homeowners who are in adjustable-rate mortgages may find it hard to find long-term financing that fits their budgets. As a result, more distressed properties should be available for real estate investors looking to do fix-and- flip projects. This may look different than it has in the past. The massive HPA of the past two years means that most homeowners, even those who desperately need to sell, have enough equity in their properties to avoid foreclosure. But investors should be able to find motivated sellers willing to take cash offers for quick turnarounds—leaving room for profit after property upgrades. The Bottom Line: Fix-and-Flip Profits Will Be Easier to Claim in This Market These three takeaways indicate why many investors will pivot toward fix-and-flip projects in this housing market.  » Fix-and-flip-eligible properties should be easier to find than they have been the past two years  » Sale values for these properties remain stable and secure  » Interest-only bridge financing makes it easier to profit on a short-term project leading to sale than on a long-term hold dependent on cash flow By learning from these takeaways, investors can design a real estate investment strategy that works in today’s market while making the most of their personal experience and skills. As you design that strategy, consider joining many other real estate investors who have shifted their focus to fix-and-flips to profit in the real estate market that has changed so dramatically in the past few months.

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An Introduction to Non-QM Programs

Why it is a Great Alternative for Borrowers By Jennifer McGuinness In the current and ever-changing market environment, it is important to understand the different financing options available to borrowers. Non-QM Programs offer a wide range of flexibility and underwriting criteria. These loans are available for the financing of primary residences, second homes and investment properties, but many do not know what non-QM means or how to get started. What is a Non-Qualified Mortgage (“Non-QM”) A non-QM mortgage loan is a home loan that is not required to meet the requirements outlined by the Consumer Financial Protection Bureau (CFPB). In January 2014, the CFPB issued a set of guidelines to provide “safer and more stable” home loans for consumers called Qualified Mortgages. Qualified Mortgages are a “new” mortgage classification. Commencing in 2014, the concept was created to make it more likely that a borrower would be able to pay back the loan. Lenders need to assess the borrower’s ability to repay and borrowers need to meet a strict set of criteria. If borrowers do not meet those criteria, they will not be approved for a qualified mortgage. In these situations, a borrower may be offered a non-qualified mortgage. A non-QM loan does not conform to the consumer protection provisions of the Dodd-Frank Act but that does not mean that they are bad for the consumer. Applicants whose incomes vary from month to month or those with other unique circumstances may qualify for these types of mortgages. For example, if you have a debt-to-income ratio of more than 43%, a lender may not offer you a qualified mortgage. Or, if you have dynamically changing income and do not meet the income verification requirements set out in Dodd-Frank and required of most lenders, you may not be offered a qualified mortgage. A lender may instead offer the borrower a non-qualified mortgage. If a lender offers a non-qualified mortgage, it does not mean the lender is not required to do any verification or assessment of your ability to repay the loan. It generally means that you do not meet the specific criteria needed for a qualified mortgage. Interest rates on loans will vary from lender to lender, but you may find that a non-qualified mortgage will have a higher interest rate. The Loan Differences While there are differences in how a Borrower qualifies for a qualified mortgage vs. a non-qualified mortgage, there are also differences in the loans themselves. Here are some of the ways the loans differ. Dodd-Frank offered lenders issuing QM mortgages protection from certain legal challenges in foreclosure proceedings and other litigation. With a QM mortgage, lenders generally have shown that they have confirmed that the borrower had the ability to repay the loan, which provides the lender with certain legal protection from lawsuits that claim they did not verify a borrower’s ability to repay. However, if a borrower does not feel that the lender made sure they had the ability to repay, they can still challenge the lender in court. Additionally, only QM mortgages can be insured, guaranteed or backed by FHA, VA, Fannie Mae or Freddie Mac, so they are generally considered  “safer” for investors who buy mortgage-backed investments. BUT IS THIS TRUE? The non-QM share of total mortgage counts declined during the COVID pandemic and reached its lowest level in 2020, at 2% of the market. However, the non-QM share of the market has since almost doubled in 2022, representing about 4% of the first mortgage market (data is as of the first three months of 2022). Though the non-QM loan is a small piece of today’s mortgage market, it plays a key role in meeting the credit needs for borrowers not able to obtain financing through Fannie Mae, Freddie Mac or other government channels. Creditworthy borrowers such as self-employed borrowers, first-time homebuyers, borrowers with substantial assets but limited income, jumbo loan borrowers and investors may benefit from non-QM loan options. The three main reasons why non-QM loans originated in 2022 did not fit in the QM requirements are the use of limited or alternative documentation, a DTI above 43% and interest-only loans. Almost 55% of the non-QM borrowers used limited or alternative documentation, 26% exceeded the 43% DTI threshold and 23% of the non-QM mortgage loans originated were interest-only loans. Today’s non-QM loans are still high-quality loans. They are very different and less risky than the equivalent of non-QM loans originated prior to the housing crisis. The average credit score of homebuyers with a non-QM mortgage loan in 2022 was 771 compared to 776 for homebuyers with QM loans and 714 for government loans (data is as of the first three months of 2022). Similarly, the average Loan to Value Ratio (“LTV”) for borrowers with non-QM mortgages was 76%, compared to 77% for borrowers with QM mortgage loans. Finally, the average DTI for homebuyers with non-QM loans was 37% versus 33% for QM and 40% for government programs. Despite the higher DTI ratios, non-QM mortgages are performing very well. Both the non-QM and QM loans have low delinquency rates. In fact, the serious delinquency rate (over 90 days delinquent) for non-QM mortgages is slightly higher than the rate for QM loans (both being less than 1%) and significantly lower than for the government loans (almost 2%). To offset the risk of default, lenders generally set a higher interest rate on non-QM loans. Additionally, lenders are generally focused on borrowers with higher credit scores and lower LTVs, as this helps to offset the possible added risk from a high DTI ratio, limited documentation and interest-only on non-QM loans. How Do Lenders Verify Income for Non-QM Loans? While non-QM loans offer flexibility for lenders to offer mortgages to people who do not fit the criteria of QM loans, lenders still need to verify the information provided and document anything that supports the borrower’s ability to repay. That includes income sources, assets, or anything else that gives them assurances the borrower will be able to repay the loan.

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