When it comes to dealing with risk, America's housing market struggles with balance. How can lenders offer affordable home mortgages for more Americans and still maintain proper safeguards?
The Great Recession was driven in part by overly risky loans that were packaged as securities and sold to investors who were unaware of the underlying risk. The resulting housing market collapse led to the Dodd-Frank regulations that regulated mortgage lending and applied credit-tightening safeguards.
Most of those safeguards are still in place, but loan offers are starting to creep back into risky territory – and investors are happy to buy up those loans looking for returns.
Dodd-Frank instituted qualifying mortgage rules – a set of lending restrictions that must be met before loans can be purchased by the mortgage loan backers Fannie Mae and Freddie Mac. Riskier unqualified loans may still be granted, but lenders don't receive protections associated with qualified mortgages.
Prior to Dodd-Frank, unconventional loans were sometimes called "liar loans" because neither side was interested in accuracy. Borrowers inflated their incomes, and lenders didn't bother to check their claims.
While unqualified/unconventional loans are still a small part of the market, the Wall Street Journal reports that unconventional mortgage loans are on the upswing – and the risk is being passed on to investors. Over $12.3 billion mortgage-backed securities containing unconventional loans were sold in 2018, far surpassing the $1 billion of 2016 sales and the $3.34 billion in 2017 sales.
Unconventional mortgages made up just below 3% of total mortgage originations in Q3 2018, continuing a steady increase from the 1.04% in Q4 2015. Through the first three quarters of 2018, $34 billion of these mortgages were issued. Over the same period, traditional mortgage loan originations fell by 1.2%
A higher percentage of unconventional loans doesn't necessarily imply a crisis. There are legitimate reasons for alternative income documentation – for example, self-employed individuals with sufficient but inconsistent incomes, or members of the gig economy who must pool multiple income sources to meet criteria. You can check your credit score and read your credit report for free within minutes by joining MoneyTips.
Mortgage industry leaders also rightly point out that loans must still meet basic "ability-to-repay" assessment rules that were put in place after the housing meltdown. This includes "reasonable care" in assessing a borrower's overall debts and obligations.
At this point, the rise in unconventional loans is just a trend to watch carefully based on past experience. As long as risk is assessed properly and passed along to both borrowers and securities investors, the housing market should stay stable.
It's a reasonable goal to help more people find homes, but not if many of those people can't afford the homes they buy. Lenders and buyers both have incentive to stretch the boundaries – which is why the current situation bears scrutiny. It's also why you should take extra care not to overextend yourself just to get a home that you may not be able to afford.
If you're relying on an unconventional mortgage loan offer, be objective about the risks involved. What are the chances you'll be able to make all loan payments over time? If you're planning on refinancing after a certain period of time, will you be likely to find a better offer with your qualifications at that time? Make sure your assumptions are reasonable and that you understand all the risks involved.
A "liar loan" may be the right loan for you – but don't let the unique loan qualifications lead you down a path of excessive risk or overspending. If you can't objectively assess the risk, seek the help of an independent and experienced mortgage professional.
MoneyTips is happy to help you get free mortgage and refinance quotes from top lenders.