“The beauty of non-QM is that whatever tricky situation a borrower might have, there is a likely solution.”

Because of these prevailing trends, mortgage brokers must explore strategies to diversify their loan products. One area to explore is the arena of nonqualified mortgages (non-QM). These are often quality loans that do not meet the strict guidelines to be purchased by the government-sponsored enterprises or the federal government.

Tightened credit

This year has been marked by a significant amount of volatility in the U.S. banking sector. The failures of Silicon Valley Bank, Signature Bank and First Republic Bank created ripples throughout the financial landscape.

In the wake of the upheaval came proposed changes to Basel III capital requirements for major banks, with regulators aiming to finalize the rules by 2025 and fully phase them in by 2028. (Basel III is an internationally recognized set of regulations developed by the Basel Committee on Banking Supervision in response to the financial crisis of the late 2000s.)

“Industry experts, banking trade groups and regulators concur that the proposed rules are poised to impede bank lending capabilities, propelling consumers toward nonbank alternatives.”

Industry experts, banking trade groups and regulators concur that the proposed rules are poised to impede bank lending capabilities, propelling consumers toward nonbank alternatives. Despite the extended timeline for compliance, banks are already experiencing a sense of urgency to align with the new rules ahead of the deadlines. This stance has led to a tightening of credit boxes, with anticipations of further constrictions in lending standards.

For example, banks reported having tightened lending standards for all categories of residential mortgages during second-quarter 2023, according to a Federal Reserve survey of senior loan officers. This scenario represents a strategic opportunity for mortgage brokers to capture the market share of borrowers turned down by banks and redirect that business toward nonbank lenders.

Lucrative opportunity

In the face of the banking crisis, mortgage brokers can offer non-QM loans to fill the void created by recent restrictions. According to the Fed survey, a significant portion of banks reported having tightened standards on non-QM jumbo loans and, to a lesser extent, non-QM loans that meet conforming loan limits.

For originators grappling with reduced loan volumes, non-QM products emerge as a lucrative revenue channel and offer a plethora of options that cater to diverse borrower needs. Three non-QM products, in particular, are witnessing a surge in demand.

The first is the debt-service-coverage ratio (DSCR) loan for investors. More than 70% of small rental properties (one to four units) are owned by individuals, and nearly all of them are managed by the same people, who are defined as mom-and-pop landlords, according to the U.S. Census Bureau. Mortgage brokers can fill the needs of this target market by offering DSCR loans, which focus on the property’s cash flow rather than the borrower’s income.

Self-employed individuals have a persistent need for creative loan solutions, and there are now about 16.5 million self-employed people in the U.S. Instead of tax returns, non-QM loans offer these borrowers alternative ways to show income, such as bank statements or profit-and-loss statements.

Non-QM lending adeptly caters to foreign nationals who inspire to invest in U.S. rental properties or vacation homes. By contrast, many banks (even before the recent banking crisis) have traditionally shied away from mortgages to international investors. There is plenty of opportunity here for mortgage brokers, with the dollar volume of U.S. residential real estate purchases by foreign buyers topping $53 billion in the year ending this past March, according to the National Association of Realtors.

Powerful solutions

The beauty of non-QM is that whatever tricky situation a borrower might have, there is a likely solution. These specialty lenders are typically known for allowing higher debt-to-income ratios (50% to 55%) and lower credit scores (low 600s or high 500s). There are powerful options afforded by non-QM for all sorts of scenarios.

For instance, loan approval for a condominium is more difficult than it is for a single-family home, especially if the condo is nonwarrantable (does not satisfy the lending criteria of Fannie Mae and Freddie Mac). Non-QM lenders specialize in lending on nonwarrantable units, whether the issue concerns construction defect litigation or lack of adequate budget reserves by the condo association.

A narrow subset of DSCR lending caters specifically to short-term rental investments such as Airbnb and condotel properties. The non-QM lenders that offer these loans have flexible guidelines geared toward the calculation of short-term rental income.

As the recent Fed survey indicated, one area that banks cut back on the most this year is non-QM jumbo loans (those sized above $726,200 for a single-family residence in most areas of the country). With banks turning away applications for large loan amounts, mortgage brokers can step in to save the day. For example, there are non-QM lenders that offer “super jumbo” loans from $3 million to $30 million.

While the demand for rate-and-term refinances has taken a nosedive, opportunity remains for brokers to originate cash-out loans, especially since non-QM lenders allow generous amounts of cash back at the closing table. There are even non-QM, no-ratio loans for owner-occupied properties. This super niche product does not verify income or employment, as long as the borrower has a strong credit score and isn’t seeking a particularly high loan-to-value ratio.

By seizing the opportunities presented by the banking crisis and the tightening of lending standards, brokers can use non-QM products to continue providing value, flexibility and diversity in their mortgage offerings. This can allow brokers to serve a broader spectrum of clients.

Effective strategies

As mortgage brokers venture into the diverse landscape of non-QM lending, it’s imperative to do so wisely. First, partner with reputable non-QM lenders. Meticulously research these potential partners before signing up with them.

The market turbulence of 2022 resulted in several non-QM lenders scaling back or ceasing their operations. More recently, some non-QM lenders have stopped offering certain niche products like the owner-occupied no-ratio loan, since it requires the lender to hold a special certification from the Community Development Financial Institutions Fund. These trends emphasize the importance of aligning with solid and reputable non-QM lenders.

Cultivate relationships with bankers, Realtors, accountants, attorneys and financial planners. Now more than ever, bankers are turning down their client’s mortgage requests. These clients would appreciate a referral to a quality mortgage broker. Engage in lunch-and-learns, particularly with Realtors. You’ll not only garner referrals to their clients but also cater to the agent’s investment property and self-employed lending needs.

Lastly, invest time to attend training workshops and acquire in-depth knowledge of each non-QM product. Establish a rapport with a proficient account executive and become well versed in the nuances of each product. This will allow a broker to pivot from selling rates (which are currently unappealing) to selling solutions.

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Mortgage brokers are strategically positioned to leverage the opportunities arising from an evolving financial ecosystem. By embracing nonbank lenders and diversifying their portfolios with non-QM lending options, brokers can address the diverse needs of borrowers and establish a book of business that’s resilient to any economic or banking uncertainties. ●

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Acting as a gatekeeper, the broker mulls over the file, finds it interesting, but reluctantly concludes, “I’ve never done anything like this before, so I’ll have to pass.” After all, the broker does not want to harm the client by overpromising and underdelivering. There is a viable alternative to turning away the deal, however. That alternative solution is co-brokering.

When presented with a new deal, the important question to ask is: “Do I truly have the required expertise to work on this deal by myself?” Answering “no” to that question is perfectly fine for many reasons.

You may not have gained enough knowledge in a niche investment scenario. Or, as a practical matter, you don’t have access to lenders that specialize in a certain type of deal. You also may be at an early point in the learning curve of a particular niche or career — a residential mortgage broker who recently branched into the commercial arena, for example.

Once you have established it is best not to go it alone, the broker’s next thought should be how to join forces with another broker. Teaming up with the right person can be a win for everyone involved — your client, the lender, the co-broker and you.

Finding a partner

The first step in finding a suitable co-broker is to closely consider the deal itself. Gather as much information as you can from the client and immerse yourself in the details. Are you able to boil down the details into a summary that immediately makes sense? In a co-brokering situation, you will have two audiences. It is not just the potential lender, but also the co-broker. You don’t want to tarnish your reputation by presenting weak deals.

If the deal is presentable and capable of being funded, the next checklist item is determining if the potential fees will be enough to share between two brokers. It is tempting to be swayed by the thought that a percentage of something is better than a percentage of nothing. Before proceeding with a deal with a co-broker, however, you should make sure the potential fees will adequately compensate you and your co-broker for the anticipated time and effort.

Consider yourself lucky if you already know a broker with the necessary expertise for the deal, and even luckier if you have successfully co-brokered with that person before. There are some practical methods to finding the right person from scratch. Ask your most trusted contacts for a personal referral. You may choose to identify lenders who specialize in the type of deal at hand and ask them which brokers they like working with the best. You also may have to do your own research, treating this as if you were a client looking for a broker with special expertise in a particular type of deal.

Whatever avenue you use to find your co-broker, it is important to find a partner whose key motivation is the desire to help the client, not just financial gain. When you present the parameters of the deal, does the co-broker immediately say, “no problem,” or does he or she ask probing questions and identify ways to address potential problems before they become deal killers? If it’s the latter, then you likely have found the right ally.

Structuring relationships

There are two main ways to structure a co-broker scenario, and this structure will depend on the level of communication you want between your client and the co-broker.

First, you can opt for an open relationship in which communication is free flowing among all parties. You, your client and the co-broker should have an initial in-depth discussion together, and then the co-broker should identify a lender and control the loan process from there. In essence, you let the co-broker be the quarterback on the field and you take on the role as the coach on the sidelines. Both of you are striving to cross the goal line. This situation makes sense if you have built up trust from prior successful deals with the co-broker, or if you have a solid noncircumvention agreement in place that prevents your client from being stolen by the co-broker if something goes wrong.

If this is your first time working with the co-broker or you cannot get a noncircumvention agreement in place, there is a second way to structure the relationship. Specifically, you can do a more segregated relationship that establishes exclusive lines of communication. In this scenario, you maintain all contact with your client, while the co-broker maintains all contact with the lender. This way, you protect your relationship with your client, while your co-broker protects his or her relationship with the lender.

Regardless of how the partnership is structured, it is a good idea to enter into a written agreement with your co-broker, or at least have a verbal understanding of how each of you will be compensated for the transaction. Sometimes it is not feasible to agree upfront to a split fee. As the deal progresses, it may become evident that one broker is doing the lion’s share of the work. To protect your reputation and preserve the possibility of working with the co-broker again, be as fair as possible.

Tips to live by

A broker who enters into a co-broker relationship should take some steps to keep the loan running smoothly toward closing.

First, the broker should strive to avoid any unpleasant surprises. Let your client and the lender know about the co-broker relationship from the get-go. Explain to the client that having two brokers is a creative and necessary way to achieve the client’s goals. The lender should know there are two brokers involved and which broker will be the main point of contact.

Second, maintain frequent communication. At the start of the relationship, make sure that you, the co-broker and the client are on the same page regarding key elements of the process, including what the rough terms, timing, fees and required documentation might be. Once a lender is interested in the deal, communication becomes even more crucial, in order to satisfy the lender with the necessary information and to push the deal to closing. Given the extra layer of parties, assure the lender that there is direct and constant communication with the borrower. Schedule regular conference calls to keep everyone on track.

Third, the broker should seek an exclusive agreement to prevent the client from shopping around. Short of that, endeavor to earn your client’s loyalty by instilling confidence that you and the co-broker are collaborating and looking out for the client’s best interests. If you’ve done a good job explaining why two brokers are necessary, your client should have no doubt about your abilities or be tempted to look elsewhere.

As with any commercial lending scenario, a successfully co-brokered loan depends on certain basic principles, such as an early examination of the borrower’s situation and needs, timely communication, and relationship and trust building. By applying simple rules through the process, two heads can indeed be better than one. Under the right circumstances, co-brokering a commercial mortgage loan can be mutually beneficial for the borrower, the lender and the co-brokers.

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Ultimately, from the commercial mortgage broker’s perspective, having two pipelines is better than having one — one pipeline of deals where the broker works alone, and a second pipeline where the broker teams up with a co- broker. Establishing a solid reputation as both an independent broker, as well as a collaborative broker, is one of the keys to building a book of business and maintaining a strong presence in the commercial real estate market.

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