'ATR, QM should not be the be-all, end-all in mortgage underwriting'

Among the difficulties lenders face when working with non-traditionally employed customers — like self-employed and gig economy workers — is not running afoul of ability-to-repay rules and the qualified mortgage definition.

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However, some lenders like New York-based Quontic Bank are finding ways to reach borrowers with needs that lie outside those boundaries. Quontic is a community development financial institution, and as such it is exempt from complying with most ATR rules. The needs of its customer base show why such exemptions are necessary, said Steve Schnall, the national lender’s CEO, president and chairman.

"The bank grew up in Queens, where there's a very diverse community, and most of the lending we had been doing historically was in low-income census tracts and to immigrants," he said. “What we found was that they require a little bit of a special type of underwriting because oftentimes, these immigrants have small businesses, or they're gig economy workers, or they're people who don't necessarily fit into the Dodd-Frank QM ATR box."

Before becoming a CDFI in 2015, Quontic used some creativity and flexibility in making loans to these borrowers, but it also found itself challenged by its regulators as they were looking at its files, Schnall said. Becoming one, “means for us is that we're able to take what we've always been doing, and build a formalized process for putting one of the homeowners into homes, using metrics other than income documentation," he said.

In Quontic's view of mortgage underwriting, equity and credit equal the ability to repay. So it has two different types of products for owner-occupied borrowers. The first is a no-ratio loan that relies strictly on borrowers making a very significant down payment, and having great credit. Quontic also offers a lite doc product where the borrower is able to provide a profit-and-loss statement from their business rather than historical tax returns.

"We're going to make the loan without putting the consumer through all these bank statement gyrations, trying to come up with a contrived value for income because the law says you have to," Schnall said.

Those "don't necessarily tell the story of what's going on in your life today, and oftentimes are not reflective of your reality,” he added. "Small business owners have a lot going on, they've got extraordinary expenses, they've got COVID, they've got full resources that don't show up [in traditional documentation], so we really cut through all that."

Quontic is looking to put people in homes while not doing anything that's unsafe, reckless or resembles the kind of nonprime mortgage underwriting that led to the last credit crisis, Schnall said.

"So our average borrower puts down 34%, has a 747 credit score, and for having characteristics like that we relieve them of having to comply with the rigid ability-to-repay rules," he said. "As a result of that, our business is growing like crazy."

These loans' "spectacular" performance validates Quontic's thesis that meaningful equity and good credit equals ability to repay while allowing the company to address the needs of underserved populations, Schnall said.

"Around 55% of our borrowers are ethnically diverse or identify as something other than white," said Schnall. "About 35% of our borrowers are purchasing property or live in low-income census tracts in the New York metropolitan area. Cumulatively, about 70% of our borrowers are low income."

Meanwhile, other lenders that may not necessarily be CDFIs, like Finance of America, have been serving consumers who don't easily fit into the conforming mold by making loans outside of the evolving qualified-mortgage box for borrowers considered to have defined indicators of an ability to repay. (While a capped debt-to-income ratio and other specific underwriting requirements will no longer define QM under the new definition going into effect, mortgage companies are still subject to offer restrictions related to how high the loan rate is and what product features are offered. In addition, they must still document and consider traditional measures like DTI, credit scores and loan-to-value ratios under broader ATR requirements when they originate loans.)

"We think consumers deserve access to innovative flexible lending, that makes sense for the borrower, and is not one-size-fits-all," said Bill Dallas, who is the president of Finance of America Mortgage and ran the nonconforming lenders First Franklin and Ownit before the financial crisis. "I think the problem with QM was the focus on debt-to-income, and I've always said this, you need to update underwriting guidelines that take into consideration a really changed consumer, in terms of the way they manage their income and assets."

A debrief of the customers from the late 1990s through 2010 determined they fell into two categories: mass non-affluent and affluent, said Dallas. The differentiator was that the affluent customers had over $100,000 in income and over $100,000 in assets. When it comes to ATR, what Dallas found was, “for the mass non-affluent, you have to be able to document less traditional sources [of income] in order to help them take advantage of jumping into the real estate market," Dallas said.

Fannie Mae, Freddie Mac and the government agencies control roughly 90% of the mortgage market today. However, they were designed to have a 65%-70% market share, Dallas noted.

"We're just going to naturally go back to that," he said. "Whether you call that non-QM or some other private-loan securitization, I think that's a big opportunity for Finance of America."

The change in the living environment for most Americans during the pandemic will feed into that trend, said Dallas.

"You've got people living in their home working in their home and renting their home [listing on sites like Airbnb and VRBO], so we've got to figure out from a lending perspective how we're going to handle what we used to call just an owner-occupied structure," Dallas said. "And I think all those things create opportunities in non-agency [lending] for us."

The aim is to use safety-and-soundness for the consumer as the guideline in order to create sustainable homeownership while addressing the needs of borrowers who may not fit in a traditional underwriting box, he said. So Finance of America uses nontraditional sources of income documentation that are less prone to fraud, such as bank statements, to help establish that.

This type of documentation is necessary because many homebuyers have multiple sources of income, such as gig economy jobs or seasonal employment at retailers during the holidays.

"I think the industry has changed, and they understand how important it is that documenting the income is essential to making sure that a customer repays," said Dallas. "Now whether that [DTI] ratio is 15 or 50[%], I don't think it matters."

When their seasonal job ends, they will have that extra income in the bank.

"We should be able to make a better credit decision and when you go in the agency market, it really doesn't work that way," said Dallas. With the GSEs' underwriting guidelines, "everything's focused on DTI, and you can get a person on with a low FICO, with high DTI, with no down payment [and] no leftover residual [income] and that's a little scary sometimes."