The share of non-QM and rebuttable presumption loans rose in the 4th quarter as reported by respondents to NAR’s 9th Survey of Mortgage Originators. While these loans are riskier than standard, prime loans, they are still at subdued levels, and in the case of non-QM loans they are entering the market in places where private capital can absorb the risk. This trend suggests a modest expansion of credit.
The Ability to Repay (ATR) rule martialed in a new set of lending rules in the spring of 2014. Lenders’ are now required to be able to prove the ability of all borrowers to repay their loans or face significant penalties. This concept sounds obvious, but definitively proving the soundness of a loan isn’t. As a result, lenders were given two standards that if met provided either clear or nearly full exemption from the ATR; a qualifed mortgage standard or a rebuttable presumption standard. Qualified mortgages enjoy the fullest legal protection for lenders and tend to be standard prime loans, while rebuttable presumption have less protection and tend to be standard loans but for lower credit scores or low down payments. Loans outside of these two definitions pose more legal risk for lenders and include interest only loans, those with points and fees greater than 3 percent of the balance, and jumbo loans with debt-to-income ratios greater than 43 percent.
Respondents in the 4th quarter survey indicated a sharp increase in the share of non-QM loans from 0.3 percent in the 3rd quarter to 1.5 percent in the 4th. The non-QM share peaked at 5.0 percent in the 3rd quarter of 2014 before pulling back sharply on weak investor demand. The share of rebuttable presumption loans increased as well, reaching 10.4 percent in the 4th quarter, not far from its peak of 12.8 percent in the 2nd quarter of 2014.
Banks tended to have the highest share of non-QM loans in the 4th quarter of 2015, while mortgage bankers drove the share of rebuttable presumption. These results likely reflect the business models of the various originators. Since there is little investor appetite for non-QM loans, non-QM loans must be held in portfolio putting bank capital at risk, while non-banks lack the capital for this type of lending. Conversely, banks have shown little interest in lending down the credit spectrum, while non-bank lenders have moved into this market both in the conventional and FHA spaces. Research by the Federal Reserve has shown that non-bank lenders tend to charge slightly higher than average rates, a trend that likely reflecting their capital structure and appropriate pricing of risk. Finally, survey respondents indicated that investor interest in non-QM loans slowed in the 4th quarter relative to the 3rd quarter, though it was expected to increase modestly over the next six months.
After contracting sharply in recent years, credit availability has slowly expanded. Unlike the heady years a decade ago, this riskier credit appears to be limited and concentrating in the portions of the market best suited to sustain it, protecting the broader market from a repeat of the subprime crisis.