Why Non-Prime Loans Are Safer Than You Think
When non-prime (or non-QM) lending returned to the market again early last year, it wasn’t welcomed back with open arms. Many critics were concerned that these products were the same as the sub-prime loans that led to the housing crisis and were afraid that history would repeat itself. In fact, sub-prime and non-QM are quite different. New regulations have helped to ease non-QM loans back into the market. Skeptics are starting to come around and realize that things truly are different this time, as non-QM products are proving to be much less risky than their predecessors.
Unlike the sub-prime loans of 2006, today’s loans have guidelines in place to alleviate risk. Here is a breakdown of what’s different today versus the past:
►Skin in the game: Higher downpayment requirements mandate that borrowers provide a significant contribution towards closing the loan. Borrowers with the riskiest credit profiles are required to put down the highest downpayments to further compensate for that risk. This practice of ensuring prudent loan-to-value (LTV) ratios makes the chances of default much less likely.
►Ability-to-repay (ATR): ATR is one of the many regulations that resulted from the Dodd-Frank Act. ATR requires that originators look at a potential borrower’s complete financial picture to make sure their existing debt obligations plus the new loan amount won’t surpass a reasonable percentage of their income. Despite popular belief, non-QM loans still need to adhere to ATR standards.