For many in the mortgage industry, 2022 is a year that won’t be missed. Rampant inflation, rising interest rates and skyrocketing home prices combined with housing, labor and material shortages, as well as substantial declines in new home construction and refinance originations. These conditions proved beyond challenging for many in the business.
First, here’s a brief recap of these market forces to show how last year started. Things look much differently now.
Inflation: In January 2021, the annualized rate of inflation was 1.4%. By January 2022, this figure had soared to 7.5%. And by September of last year, it was 8.2%.
Interest rates: In January 2021, the average rate for a 30-year fixed mortgage was 2.74%, Freddie Mac reported. A year later, it was 3.45%. As of early November 2022, it was 6.95%.
Home prices: In first-quarter 2021, the nationwide median price for all types of existing homes was $369,800, according to Federal Reserve data. In Q1 2022, it was $433,100, and by Q3 2022, it was $454,900.
Higher wages and material costs for new construction have led to significant declines in housing starts and renovation projects. All of these factors, naturally, have taken a toll on mortgage lenders.
In the conventional market, all lenders are on a level field during tough market cycles.
Originations have suffered drastically, with refi applications down 87% year over year in early November 2022, according to the Mortgage Bankers Association (MBA). Purchase loan applications declined by 41% during the same period, while total origination volume for 2022 is expected to drop 49.1% from the year before, MBA reported. Last year entered grim economic territory that isn’t expected to ease anytime soon.
Given the distressing economic situation that all businesses are currently facing, it’s important to distinguish how differently these circumstances affect the conventional and nonqualified mortgage (non-QM) markets. Non-QM loans differ from conventional mortgages in that they are neither guaranteed by the U.S. government nor eligible for purchase by the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.
In the conventional market, all lenders are on a level field during tough market cycles. If a lender is an approved seller/servicer — whether big or small — they know with certainty that they will be able to sell their loans to Fannie or Freddie. Furthermore, they know that the GSEs set the same purchase price for the loans they buy from all conventional lenders. This guarantee that their loans will be sold at a set price provides enviable stability and liquidity to their businesses.
In a high interest rate environment, however, the profit margins they receive when selling their loans shrink substantially. Margin compression is the main difficulty that conventional lenders are facing in these turbulent times. Unfortunately, for many conventional lenders, their current production costs often exceed their margins, placing them in negative profitability.
Additionally, some of the market leaders in conventional lending decided in the second half of 2022 to aggressively lower their rates to attract homebuyers who still are shopping in this depressed market. This has put even more pressure on the small and medium-sized lenders, which may be struggling to compete. These same large conventional lenders have used advanced technology as a tool to help substantially lower their production costs compared to their smaller competitors. Consequently, many conventional lenders have had to sharply curtail production, or even cease operations, due to these hardships.
Although working under a different set of circumstances than conventional lenders, non-QM lenders also had tough sledding in 2022. Since their mortgages are not guaranteed to be purchased by the GSEs, non-QM lenders that want to sell their loans must package and bring them to the investment market.
Few non-QM lenders have direct access to the market. They commonly sell their loans to aggregators, who decide the price they will pay based on their assessment of how the market is performing now and how it might perform in the future. Because of the bleak market conditions in 2022, these aggregators offered reduced prices for these securitization packages, causing many non-QM lenders to suffer financially.
This situation pushed a lot of companies out of the non-QM market last year as sales prices deteriorated over time and loans couldn’t be liquidated quickly enough. This led to several non-QM lenders having to abruptly cease operations in the latter half of 2022, while others substantially cut back their production.
In the non-QM world, there are only a handful of lenders with direct market access, meaning they are not at the mercy of how aggregators set prices. These companies can transact their own private-label securitizations and, as a result, they can sell their loans at substantially higher prices. These companies are the ones that have been able to successfully navigate the choppy waters of 2022.
While no one has a crystal ball, the Federal Reserve could very well have inflation under control by the end of first-quarter 2023, which would stabilize interest rates or possibly even cause them to drop. Still, when compared to the mid-to-late 2010s, interest rates will remain comparatively higher for the foreseeable future.
In early 2022, housing inventory was in short supply, which drove prices to record highs. It is expected that in 2023, inventory will continue to increase and help to soften home prices. So, for the borrowers who will be in the market to buy a home, there should be more homes available to purchase.
Many analysts predict that the U.S. economy will officially enter a recession in second-quarter 2023. Paradoxically, previous recessions have helped non-QM lenders. Borrowers are more likely to qualify for a non-QM loan versus a conventional loan during these times. Why? Because non-QM lenders have alternative ways to qualify borrowers who either have nontraditional means of income documentation or have had disruptions to their finances.
Traditionally, conventional lenders only use tax returns or W-2 forms to show an ability to repay and qualify a borrower. Non-QM lenders can use a wider variety of income-verification documents, including personal and business bank statements, profit-and-loss statements, IRS 1099 forms and written verifications of employment. In some cases, no verifications are needed.
When interest rates are at 3%, more borrowers are likely to qualify for a conventional loan. These same people may not qualify, however, when rates are at 7%. If they want a mortgage, their originators should help them seek out a non-QM product. Demand for housing is relatively constant and borrowers still need to buy homes — even if the rate is not as attractive as they wish.
They can always apply to refinance into a less expensive option in the future, which opens another refinance market down the road. Also, this is a time when more people are becoming self-employed. These workers often have difficulty qualifying for a conventional loan due to nontraditional income documentation, but this does not disqualify them from a non-QM loan.
In addition to the self-employed, creditworthy borrowers such as first-time homebuyers, those with limited income but substantial liquid assets, jumbo loan borrowers and real estate investors may receive help from non-QM loan options. Lastly, borrowers whose income may have been affected by the COVID-19 pandemic or the recent economic upheavals also might struggle to qualify for conventional or government-backed loans.
Given these circumstances, it’s expected that the non-QM channel will continue to grow and develop as the market stabilizes in 2023. Originators should consider partnering with a non-QM lender that creates its own guidelines, controls its own destiny, has direct access to the securitization markets and isn’t forced to arbitrarily sell its loans at unsustainable prices.
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With all that has happened in 2022, and given what the expectations are for 2023, mortgage originators would be wise to align themselves with a successful and stable non-QM partner as an alternative to conventional lenders. For 2023 and beyond, non-QM is an increasingly practical and profitable option. ●
Max Slyusarchuk is the founder and CEO of A&D Mortgage, a full-service lender offering a wide spectrum of conventional and non-QM loan products. Slyusarchuk has more than 20 years of mortgage- and banking-industry experience, and is an expert in non-QM mortgage lending.
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