Lenders issued 34 billion of non QM (Qualified Mortgage) loans in the first three quarters of 2018, a 24% increase from the same period a year earlier. Why is this mortgage segment growing so quickly while conventional loans are languishing? How are these loans underwritten compared to other mortgages? With Dodd Frank, isn’t the market safer?
What is Subprime lending and why is this important?
Subprime lending (or non-prime) is basically any loan where the borrower puts less than 20% down and/or doesn’t meet traditional credit/income guidelines. A new name for subprime is Non-QM (non-qualified mortgage)
Wait, everything is different now in the mortgage market! We cannot have the same issues again with Dodd Frank, etc…!
I hear the arguments now, default rates are at the lowest since the recession, underwriting is tougher, credit scores are higher and the list goes on. Unfortunately, none of these arguments hold water, subprime is back. The Government always seems to be two steps behind the market.
How are lenders getting around Dodd Frank?
The market has a way of making products work with the new legislation. Under the new legislation, one of the pillars on an owner occupied home is that you have to prove the ability of the borrower to repay. This sounds simple enough, but there is considerable leeway in defining income.
One of the new twists is Airbnb income and other short-term rental income is now counted the same way as normal wage income. Also, income from side gigs can be counted as income by examining bank statements.
What is the problem?
On the surface, it seems plausible to count all these other sources of income, but there is one problem. Short term income like from providing nightly rentals for rooms in your house and also “side gigs” are much more volatile in economic cycles.
For example, Vail resorts stock has dropped 39% due to a decline in “destination visitation”. Let’s say you bought a home in Breckenridge and to help pay the mortgage you rented out rooms nightly as destination visitation has dropped two things happened 1) your nightly rates dropped 2) the number of rentals dropped. With less demand from out of town visitors, one or both events occurred which will lead to a decline in revenue. If a borrower were depending on this revenue to pay their mortgage, they have a huge problem.
There is one other big problem. Rules for nightly rentals are changing rapidly, what happens when a city enacts a rule that bans nightly rentals? This happened in Lake Tahoe and will likely happen in other cities as they grasp with the huge influx of rentals. That income is now gone and the homeowner has a huge problem as short term rentals are exponentially more profitable than longer term rentals.
What happens in a downturn?
A cascading effect occurs; the market falls, dampens consumer confidence, decreases consumer spending and businesses in turn cut back to accommodate the lower spending level. The first things to go are discretionary purchases. Nobody needs to take the vacation to Denver or Atlanta, when times get tough travel is the first thing to go and so is the revenue from these stays.
How people make money in the “new economy” is changing
The way people make a living in the new economy is rapidly changing, financial products and regulations are struggling to keep up with the pace of change. Since the last recession, the economy has changed drastically with Airbnb, vrbo, uber, lyft, etc…. How people make money has changed as a result of these structural economic changes.
To accommodate the “new economy” financial products have adapted as well. Currently in a good economy, like today, all the new lending products look like a great idea. As the economy now begins a new phase of slower growth (or possibly a correction or a recession) we will get to see how well the new products hold up under stress and ultimately how investors fare. If the last recession is any indicator, these new products will have a rough road in a changing economy.
I need your help!
Don’t worry, I’m not asking you to wire money to your long-lost cousin that is going to give you a million dollars if you just send them your bank account! I do need your help though, please like and share our articles on linkedin, twitter, facebook, and other social media. I would greatly appreciate it.
Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).