As banks and mortgage lenders parse the requirements of the Consumer Financial Protection Bureau's ultra-safe "qualified mortgage" rule, they are finding that self-employed borrowers typically fall outside the definition of QM. The self-employed and sole proprietors of small businesses, from plumbers to interior decorators to caterers, may have the hardest time proving their income from bonuses or commissions, and may have high debt-to-income ratios because they typically list the lowest possible income on their tax returns.
Industry experts say some banks will be leery about originating loans to the self-employed out of fear they will be unable to document the borrower's ability to repay. They also may be reluctant to make loans to these folks because, either due to the new rules or the loan amount, such loans cannot be sold to Fannie Mae or Freddie Mac.
But some lenders say they will continue lending to self-employed borrowers because, if they don't, someone else surely will. In most cases, they plan to make non-QM loans to these borrowers and then keep them on their balance sheets.
"What you are going to find is lenders will tread lightly into the non-QM world," says Matthew Clarke, the chief operating officer and chief financial officer at Churchill Mortgage in Nashville, Tenn. "We do believe there are good risks."
Under the new mortgage rules, borrowers must have a debt-to-income ratio of less than 43% to be considered a "qualified mortgage," which gives lenders the greatest protection from lawsuits. Loans that fall outside the new rules are considered non-QM and have fewer legal protections.
Robert Messer, the chief financial officer at the $2-billion-asset American National Bank of Texas in Dallas, says that his bank will continue lending to self-employed individuals and small-business owners because they are generally good borrowers even if their income stream is erratic. He gave an example of a factory owner whose adult son wanted to buy a house but could not qualify for a home loan on his own. He would make the loan, he says, because the father, a longtime customer, has enough assets to ensure the ability to repay it.
"We talked about only doing QM loans and we decided within eight minutes that we are going to do non-QM loans," he says. He adds that roughly 11% of the loans his bank originated last year would not meet the QM definition this year
There are roughly 9.2 million self-employed workers in the U.S., representing more than 6% of the American work force, according to December data from the Bureau of Labor Statistics.
Many self-employed borrowers in high-cost states like California must obtain a jumbo mortgage, which exceeds the conventional conforming loan limits of $625,000 set by Fannie Mae and Freddie Mac. If lenders choose to originate these non-QM loans, they must hold the loans on their balance sheets.
Joe Thomas, a managing director at Hovde Private Equity Advisors, who is chairman of the $440-million-asset Bay Bancorp in Lutherville, Md., says some community banks are going to originate non-QM loans simply they need the assets in what is fiercely competitive lending environment.
"Because we're trying to differentiate ourselves with owner-managed businesses, we'll bring in a mortgage banker to originate a non-QM loan that is higher balance, and perhaps not in complete compliance with QM underwriting requirements," Thomas says. "This is a relationship strategy."
For now, most banks looking to generate more net interest income are sticking with interest-only or jumbo loans that would be considered non-QM. While there is not yet a secondary market outlet for non-QM loans, many expect that to develop over time. Holding loans on balance sheet also is attractive in lieu of buying 30-year mortgage-backed securities that are subject to mark-to-market accounting rules.
Competition for non-QM loans could heat up this year as lenders grapple with a shrinking home purchase market. The Mortgage Bankers Association, which predicted in October that lending volume would drop 32% this year to $1.2 trillion, is expected this week to cut that forecast even further.
"I do think we're heading into a difficult environment in 2014 with the cost of doing business up and overall volumes coming down, so there is pressure," says Tom Wind, an executive vice president and head of home lending at $17.6 billion-asset EverBank Financial in Jacksonville, Fla. "The home purchase market just isn't going to replace the amount of refinancing volume from last year."
EverBank also plans to originate non-QM loans mainly for high credit quality borrowers even if they have high debt-to-income levels or other circumstances in which their income has been reduced.
"People who do have significant assets or have down-sized in their career, we have the ability to do a calculation to dissipate their assets over the life of the loan and use that to qualify them," Wind says.
American National's Messer says that once the anxiety over QM subsides, many banks will recognize that non-QM loans, properly underwritten, are worth making. And if they don't, banks like his will be more than ready to steal their mortgage customers—and cross-sell them more products and services.
"The unintended consequence of the QM rule is there will be some individuals who merit owning a home and they will not be able to buy one because they don't fit the box," he says. "If a borrower is with a bank that will only do a QM, and we do their mortgage, shame on us if we can't get the rest of their business."