Rising Trends and the Impact of Non-QM and DSCR Lending
Factors Influencing Alternative Lending Products
By Amy Kame
This article will delve into the rising trends and the impact of non-QM and DSCR lending on today’s housing market.
The Evolution of Non-QM and DSCR Lending
The aftermath of the Great Financial Crisis prompted a shift in the mortgage industry’s approach to underwriting. To mitigate risks, mortgage originations saw a tightening of standards, with increased documentation and verification requirements. In response, government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac introduced Qualified Mortgages (QMs) to establish safer and more sustainable options for consumers. QMs meet specific requirements set by the Consumer Financial Protection Bureau (CFPB) and are assumed to comply with the Ability-to-Repay (ATR) Rule.
Non-QM loans, conversely, do not fulfill all QM requirements and are not required to meet the federal government and CFPB guidelines for qualified mortgages. Some characteristics that render loans as non-QM include limited documentation, debt-to-income (DTI) ratios greater than 43%, interest-only periods, terms exceeding 360 months, and lower FICO scores.
In recent years, non-QM loans have gained traction in the real estate market. This growth is partly attributed to the introduction of debt service coverage ratio (DSCR) loans, where lending decisions are based on the cash flow generated by investment properties instead of the borrower’s personal income. Other non-QM products, such as bank statement loans and asset- based loans, offer unique solutions for borrowers with unconventional income sources or complex financial profiles.
The non-QM market is poised for long-term, sustainable growth. The market faced liquidity limitations during the pandemic and reached its lowest level in 2020, at 2% of the market. Non-QM reclaimed its share in 2021 and almost doubled in 2022, representing about 4% of the first mortgage market (CoreLogic).
Factors Influencing Alternative Lending Products
Several pivotal factors currently influence the Non-QM and DSCR lending markets, such as rising interest rates, the evolving landscape of the securitization market, shifting demographics, and growing investor demand coupled with an aging housing stock. Together, these interconnected threads define the outlook of the non-QM and DSCR lending markets.
The Impact of Rising Interest Rates and The Securitization Market
The housing market faced challenges in Q1 2023 due to a surge in mortgage rates. Toward the end of 2022, rates reached over 6%, the highest level since 2008, up from just 3% at the start of the year. Unlike traditional agency loans, non-QM loans must be securitized and sold to secondary market investors, and dramatic pricing changes caused a liquidity squeeze. Lenders holding older loans with lower interest rates struggled to sell or exit them, resulting in pipeline freezes, which led to shutdowns, bankruptcies, and layoffs across the non-QM lending space.
Although non-QM loans faced challenges in the secondary market at the end of 2022, there have been recent signs of recovery, as evidenced by securitizations from companies like Angel Oak Mortgage and A&D Mortgage.
In June 2023, Angel Oak Mortgage REIT Inc. issued a nearly $285 million securitization primarily backed by non-QM loans, viewing it as an “inflection point” for the company. The securitization received a AAA rating from Fitch Ratings, signaling investor confidence in the asset class. Similarly, in February, Fitch provided positive ratings to A&D Mortgage’s securitization, indicating that the securitization market for non-QM loans is gaining traction.
As we continue through 2023, rates remain elevated, and originators have increased their non- QM product offerings, which provide borrowers with immediate relief through reduced monthly mortgage payments. The surge in interest rates has also prompted potential home buyers to opt for renting, resulting in a thriving rental market. Fitch reported a heightened focus from originators on attracting borrowers interested in DSCR products to drive production. These trends in the current lending landscape underscore the industry’s adaptability to changing market conditions.
Demographics and The Self-Employment Trend
Demographics play a pivotal role in shaping the housing market, and the rise of the millennial generation has significant implications. With over 72 million individuals, millennials constitute the largest population cohort in U.S. history. As millennials settle down, start families, and enter the housing market, their housing needs have significant repercussions for the market.
Millennials also represent a considerable segment of the largest non-QM borrower cohort: the self-employed. The pandemic shifted traditional work culture, making remote work and self- employment more common. This newfound flexibility enables self-employed workers to move around the country and purchase homes in more affordable areas.
One of the biggest misconceptions about non-QM loans is that they are exclusively for borrowers with poor credit. In reality, today’s non-QM loan pools often feature borrowers with FICO scores ranging between 730 and 740, DTIs that meet agency standards, and LTVs in the low 70s (CoreLogic). The growing trend of self-employed borrowers seeking non-QM products highlights the flexibility of this product to meet the needs of diverse borrowers.
Investor Demand and America’s Aging Housing Stock
The aging U.S. housing stock presents another key trend influencing the housing market. According to the National Association of Home Builders, the median age of owner-occupied homes is about 40 years. The residential construction industry has struggled to keep up with the demand for new homes, leading to insufficient supply.
Moreover, investor demand for rental products has surged as property investors purchase single-family homes from downsizing baby boomers, refurbish them, and convert them into rental properties. This trend is another indication of the non-QM sector’s adaptability to serve the market’s evolving needs. The flexibility of non-QM lending allows lenders to quickly align products and services with shifting industry demands.
The impact of rising interest rates, demographic shifts, and evolving investor preferences are driving change in the industry. The non-QM sector has shown resilience and adaptability as the industry navigates these trends.
Non-QM and DSCR Lenders Embrace NPLA Conference
The decision of NPLA and the National Private Lenders Conference to expand our offerings to Non-QM and DSCR lenders shows our commitment to the evolving real estate market. The conference empowers industry professionals to stay informed about the latest trends and developments by providing education and opportunities within these growing segments. This expansion showcases the NPLA’s dedication to industry advancement and will undoubtedly foster innovation and growth in the private lending space.
Non-QM and DSCR lending have emerged as significant forces in today’s dynamic housing market, catering to a diverse range of borrowers and investors. As these lending segments evolve to meet shifting industry trends, industry professionals can access a platform through the NPLA that promotes collaboration, networking, and knowledge sharing. In the years ahead, the non-QM and DSCR markets are expected to thrive, bolstered by forward-thinking initiatives and the commitment of industry leaders to embrace change and opportunities in the market.
Become a part of the NPLA community — Join us at our first conference of 2024 in Miami, Florida, at the beautiful Lowes Miami Beach Hotel from March 7-9.
SIDEBAR
The National Private Lenders Association and the NPLA Conference have long been at the forefront of serving the private lending space, facilitating commerce between capital providers, lenders, investors, brokers, and service providers. The NPLA has been a driving force in industry advancement. In a strategic move to address the changing landscape of the real estate market, the NPLA Conference is now offering education and networking opportunities for non-QM and DSCR lenders.
Join us in person for more of these insights at the next NPLA Conference in Austin, Texas, October 15-17 at the Fairmont Hotel.
