Tom Davis, Author at Scotsman Guide

Invest in Your Future

Tom Davis — Sun, 01 Oct 2023 08:00:00 +0000

Over the past few years, wholesale mortgage companies have seen an uptick in mortgage brokers who are eager to expand their business by offering debt-service-coverage ratio (DSCR) loans. These funding mechanisms qualify borrowers based on the income generated by an investment property and are used to cover monthly debt-service payments.

“A perfect storm of economic and housing factors conducive to a strong rental market is driving the sustained spike in DSCR loan demand.”

DSCR loans are also specifically geared to meet the needs of investors who are purchasing various types of real estate. These include single- family rentals, townhomes, two- to four-unit properties, warrantable or nonwarrantable condominiums, and planned unit developments.

Supply growth

A perfect storm of economic and housing factors conducive to a strong rental market is driving the sustained spike in DSCR loan demand. Millennials — today’s largest housing cohort — have new and growing families that require more space. Many are renting single-family residences in built-to-rent communities until they can find and afford a home of their own.

From September 2021 to September 2022, the number of built-to-rent homes delivered across the U.S. increased by 42%, according to the National Association of Home Builders. The conversion of commercial buildings into multifamily housing is also a growing trend in multiple markets, according to the Urban Land Institute and the National Multifamily Housing Council Research Foundation. Here are some other pertinent statistics:

According to a Roofstock study, approximately 10.6 million Americans derive income from a total of more than 17 million rental properties.

CoreLogic notes that real estate investors were responsible for 27% of single-family home purchases in first-quarter 2023, with transactions from small- and medium-sized investors representing the bulk of this activity.

The U.S. Census Bureau estimates that 81,000 single-family rentals were started last year, a record-high number that accounted for at least 8% of all new construction.

Meanwhile, the movement toward apartment living remains robust, especially in urban core neighborhoods. When looking exclusively at apartment construction in downtown areas, Atlanta led the nation by adding more than 21,000 units from 2013 to 2022, according to StorageCafe. Other cities that followed close behind include Los Angeles, Houston, Charlotte and Miami.

Solving challenges

Investors value the speed and relative ease of procuring DSCR loans, especially in hot markets where there is heavy competition for properties. Equally valuable to these investors are knowledgeable mortgage brokers, who know how these loans can overcome common financing challenges.

For example, new Fannie Mae and Freddie Mac guidelines recently imposed on condominiums have narrowed the definition of a warrantable condo. Investors looking to add rental condos to their portfolios often must turn to DSCR loans to purchase nonwarrantable units. Additionally, Fannie and Freddie will not back loans to investors who already own 10 financed properties. But DSCR loans do not have this limitation.

Beyond solving these common challenges, there are other reasons why experienced investors find DSCR loans to be particularly advantageous. Often, as they’re finalizing one deal, they’re thinking about their future expansion strategy. Many DSCR products come with a cash-out option, providing the equity these borrowers need to grow their portfolios.

Many property investors, following their accountant’s advice, continually swap properties for a tax advantage through a 1031 exchange. These transactions allow a borrower to sell one property and buy a “like-kind” property within a specific time frame. This swap enables the investor to defer capital-gains taxes. A DSCR loan is easy to do and quick to close, which is helpful in meeting the time requirements for a 1031 exchange.

Still other investors with particularly complex paperwork are attracted to the more compressed timeline inherent to DSCR loans. For example, if they’re in a rush to acquire a short-term rental in the Rockies in time for ski season, they simply don’t want the transaction to be delayed by intensive documentation and a protracted underwriting process.

Qualifying cash flow

When mortgage brokers and their nonqualified mortgage (non-QM) lender partners qualify investors and properties, they focus primarily on projected cash flow. Will the property or properties they’re purchasing provide enough income to cover the mortgage and other recurring costs?

To answer this question, they do some simple math. First, they calculate the investor’s monthly gross rental income, based on the lower of two measurements. The first is the 12-month average of short-term rental income, while the second involves the comparable market rent from either Fannie Mae Form 1007 (for a single-family property) or Form 1025 (for properties with two to four units).

This number is then divided by the investor’s expected monthly expenses, also known as PITIA (principal, interest, taxes, insurance and homeowners association fees). The quotient represents the investor’s debt-service-coverage ratio.

If the ratio is 1.0 (i.e., breaking even), the lender can expect that the borrower will have the funds to repay the loan. A ratio that exceeds 1.0 indicates positive cash flow even after accounting for monthly expenses. These numbers will factor into a lender’s final decision and the terms they offer. Some non-QM lenders will provide DSCR loans to investors whose ratio is less than 1.0, if they have other assets to compensate for a shortfall.

Terms and requirements for any of these loans will vary by lender. Common ones include a maximum loan-to-value ratio of 80%, six months of reserves held in a federally insured U.S. bank, or the ability to vest through a limited liability company or corporation.

Get the business

The question remains: How can brokers leverage opportunities to meet a property investor’s specific needs while keeping their loan pipeline flowing?

First, brokers should build their referral networks with a focus on investors and industry peers. Realtors, attorneys, accountants, financial advisers and builders are all excellent referral sources for real estate investors. This is especially true in areas experiencing high annualized rent growth, such as Boston; Hartford, Connecticut; Providence, Rhode Island; Cincinnati; and Chicago.

Second, jump on every chance to build partnerships. The minute that new construction breaks ground, it’s time to call the builder or Realtor involved and offer to help them quickly move every residential unit through a streamlined cash-flow lending process. Speed is important to a Realtor’s investor clients and they need DSCR lending experts who can help them provide quick service.

Make sure to partner with experienced non-QM lenders with a strong track record in DSCR loans. Longevity, dedicated expertise and a focus on true channel-based partnerships are valuable qualities in a lending partner. Look for companies that offer education and training, scenario-desk resources, and assistance with marketing, prospecting and joint presentations to Realtors and other referral partners.

As new investment properties continue to reshape the real estate market, brokers who master DSCR loans stand to benefit in multiple ways. They’ll increase their number of referrals and repeat clients — and ultimately their profits. ●

The post Invest in Your Future appeared first on Scotsman Guide.

Rev Up the Engine for Non-QM Lending

Tom Davis — Wed, 01 Feb 2023 10:00:00 +0000

It’s 7:30 a.m. and Steve, a successful IT security executive, has five minutes to get his 10-year-old twins into the car and off to school. He runs downstairs from his home office, only to find that the kitchen drawer where he keeps his car keys is empty. This sets off a frantic search throughout the house and eventually leads back to his home office, where the keys were on his desk all along.

What does this have to do with mortgage lending? Everything. These days, many mortgage originators likely feel like Steve, running in all directions to find the product opportunities they’ve lost. After all, nationwide purchase and refinance origination volume have decreased dramatically, and the concurrent rise in interest rates has eliminated many potential homebuyers from the market.

The mortgage originators who have successfully navigated the non-QM space know how to color outside the lines.

Brokers and lenders, however, could begin selling nonqualified mortgages (non-QM) or take steps to increase their non-QM market share. They only need the right resources and expertise. The opportunity is literally on their desks.

Market opportunity

While an increase in self-employment continues to swell demand for non-QM mortgages, it’s common to find mortgage professionals who have never originated a non-QM loan. Today’s non-QM borrowers have strong credit but might not check all the boxes to qualify for a conventional government-backed mortgage.

For example, it can be easier to qualify for a conventional loan by providing a W-2 form to document taxable income. Many potential borrowers, however, are freelancers, gig-economy workers or entrepreneurs who don’t have this traditional documentation. The U.S. workforce included 16.8 million self-employed people as of June 2022, up 1.4 million over a two-year period, according to a Bloomberg analysis of U.S. labor statistics.

These individuals often have the resources to buy a home but lack connection to a mortgage originator who has confidence in their creditworthiness. They might be part of the real estate investment wave, joining the approximately 10.6 million Americans who draw a large portion of their income from rental properties. These investors may be self-employed or need a loan that exceeds the limits of government-sponsored mortgage ceilings.

These borrowers also could be high net worth individuals who don’t work but who routinely purchase and sell homes to hedge against risks and rebalance their assets. In addition, there are individuals who are recovering from a recent credit impairment and may still qualify to be underwritten with appropriate terms in place.

Qualification scenarios

Qualifying a borrower for a non-QM loan is different than qualifying a borrower using a standard set of products based on a narrow list of criteria for a government-sponsored mortgage. The mortgage originators who have successfully navigated the non-QM space know how to color outside the lines. They have the expertise to use alternative criteria to match responsible, creditworthy borrowers with the appropriate loans for their situation.

Take, for example, a self-employed borrower without a W-2 tax form who provides 12 to 24 months of personal or business bank statements. A non-QM lender could then calculate their qualifying income based on a standard expense factor (e.g. 50%). They also could use a profit-and-loss statement or an expense statement prepared by a third-party tax professional.

An individual investing in a rental property might qualify for a debt-service-coverage ratio (DSCR) loan based on the cash flow generated by their properties, as long as the total rental cash flow equals or exceeds their ongoing expenses (mortgage, taxes and insurance). High net worth individuals, meanwhile, may qualify based on the income from their investments and the value of other assets.

Product flexibility

In addition to enabling more flexible client credentials, non-QM lending opens up a new set of product options and features. Originators must simply commit to mastering the nuances.

Providers of government-sponsored mortgages, for instance, frequently require that borrowers have a debt-to-income (DTI) ratio of 43% or less. With non-QM loans, however, some lenders will underwrite loans for borrowers with DTIs of up to 50%.

Lenders also will manufacture loans for many borrowers whose loan-to-value ratios reach as high as 90%, with no accompanying mortgage insurance requirement. While non-QM lenders are still required to confirm a borrower’s ability to repay the loan, they have more flexibility in how to qualify them.

For originators wanting to expand their offerings into the business-purpose investment market (such as single-family homes and properties with two to four units), a variety of DSCR loans fall under the non-QM umbrella. These products include interest-only options and cash-out solutions to expand liquidity for future investments. These wide-ranging products can increase an originator’s repeat business opportunities as investors seek additional financing to build out their portfolios.

In this inflationary period, mortgage originators competing in the non-QM space also must master a new mindset of selling monthly payments versus interest rates. For example, a prospective borrower who is deterred by current interest rates may be intrigued by a 40-year non-QM loan that allows for interest-only payments during the first 10 years before converting to a 30-year fixed-rate loan.

As an alternative, a self-employed borrower who plans to live in his or her next house for five years might be tempted to rent until they learn about an adjustable-rate non-QM mortgage. This way, they can lock in a comfortable range of monthly payments during this relatively short period.

Essential tools

Given the plethora of non-QM products, how can mortgage originators improve their expertise as quickly as possible? There are some “essentials” that will help get them up to speed.

Quick prequalification tools to evaluate borrower credentials and property income, and to view a variety of potential product options
Bank-statement analysis tools to delve into borrower income and cash flow
Scenario desks staffed by wholesale and correspondent lender partners who can help to evaluate borrower credentials, review potential loan scenarios, analyze appraisal and property data, answer general questions and help structure deals.

It also is valuable advice for brokers to work with lenders that have in-house underwriters with vast experience in the nuances of non-QM loans. As independent mortgage brokers and loan officers move into non-QM lending, they will discover that professional-services providers outside of their current referral base — such as accountants, attorneys, financial planners and wealth managers — are valuable sources of leads and knowledge.

Mortgage brokers and loan officers, too, can educate their professional-services partners on the most recent non-QM trends that may be helpful to their clients. Indeed, success in the non-QM lending world is based both on what originators know and who they know. It’s a matter of noticing the keys to growth that are right in front of them. ●

The post Rev Up the Engine for Non-QM Lending appeared first on Scotsman Guide.

Time to Hone Your Craft

Tom Davis — Mon, 01 Aug 2022 09:00:00 +0000

When it comes to non-qualified mortgage (non-QM) loans — those that fall short of the requirements to be purchased by Fannie Mae or Freddie Mac — the mortgage industry has crossed a threshold. Mortgage brokers and loan officers who have never previously offered non-QM products are starting to do so.

A changing business environment has fueled their interest. The mortgage industry is facing a perfect storm. First, refinances that sustained originators for so long are expected to decline by 69% this year compared to 2021, according to a Mortgage Bankers Association forecast from June 2022. Now they need to compensate with more home-purchase originations.

Meanwhile, interest rates for 30-year fixed loans reached their highest levels in 13 years and inventory remains tight. An April 2022 Realtor.com report noted that for every five homes available for sale when the COVID-19 pandemic started, there are now only two. Homebuyers, who may feel this is their last chance to secure the home they want, need originators who can help them find financing fast.

Prime prospects

These prospective buyers include large pools of potential candidates who may not qualify for a traditional mortgage. Often, however, they are excellent prospects for non-QM products — assuming that a mortgage broker or loan officer has the expertise to provide them. For example:

There are 16 million self-employed individuals in the U.S., according to the Pew Research Center. These people may not have the employment documentation required for a traditional mortgage, but they may have alternative documentation to qualify for a non-QM loan.
Investors are buying up homes for rental or fix-and-flip purposes. These buyers are typically candidates for debt-service-coverage ratio (DSCR) loans, a subset of non-QM. Redfin noted that 18.4% of all U.S. homes sold in fourth-quarter 2021 were bought by investors, compared to 12.6% a year earlier.
Many high net worth individuals routinely purchase and sell homes to rebalance their portfolios of assets. Non-QM loans that offer higher amounts than agency-backed mortgages provide them with the liquidity to do so.
About 8% of all mortgage applications are declined at any given time. These prospects fall out of the manufacturing line for various reasons, but this doesn’t necessarily mean they’re not creditworthy. If an originator has already put time and money into these leads, they may have the ability to help close a sale by using a non-QM option.

There is opportunity in this segment, but that doesn’t always equate to easy access. Non-QM mortgages are not commodities. Matching the right borrowers with the right products requires specialized training and knowledge. Originators can pursue this training and knowledge to master the non-QM segment and become the go-to experts in their locality.

Develop expertise

Successful non-QM lending is not a reactive process — it is more of a proactive, deliberate and “by design” approach. The more knowledgeable an originator is regarding the nuances of non-QM lending, the better equipped they will be to evaluate each loan scenario and recommend the appropriate product.

If an originator is looking to capture more business-purpose investor clients, then they’ll need to strengthen their knowledge of DSCR products. This includes what kinds of properties qualify; how to determine whether a client’s property income and cash flow will be sufficient; maximum loan amounts and loan-to-value ratios; downpayment and reserve requirements; credit scores; cash-out options and more.

If they want to serve “well-heeled” borrowers who are seeking a mortgage for a primary residence, originators will require education on a variety of non-QM product options (including 40-year mortgages and interest-only loans). They’ll need to know the flexibility for terms such as debt-to-income ratios along with the data and documentation that underwriters will require (from bank statements to 1099 forms). If they seek a niche that supports borrowers recovering from recent credit events, they’ll need to understand the eligibility criteria that must be met.

Technology and resources

Imagine that a potential borrower is on the phone with a mortgage broker, having just been turned down for a traditional mortgage after leaving a job to start a consulting business. The client has his eye on a $1.5 million home to be used as a primary residence and has enough savings for a 20% downpayment and monthly payments of up to $8,000 for a year. But he really wants to conserve this cash for his new business venture and would like a non-QM loan.

A broker who has recently started to provide non-QM products may not know which type of loan this prospect may qualify for. What is the maximum loan amount? Can the broker offer the buyer the choice of a fixed-rate or an adjustable-rate mortgage? What documentation will the borrower need to provide and how much money will they be required to hold in reserve?

These are the kinds of situations where technology can be valuable. For example, wholesale non-QM lenders publish complimentary online tools, such as Quick Qualifiers, to help originators advise prospects at the point of inquiry.

From there, lenders help their channel partners with loan structuring and pricing, analysis of bank statements and other documentation, appraisal reviews, credit grading, and responses to general non-QM questions. If they have in-house underwriters, they can advise on whether exceptions can be made based on compensating factors, such as large amounts of reserves or high credit scores.

Look to lenders

Wholesale lenders that live and breathe non-QM products are eager to train their lending partners. The information they pass along can include products, sourcing, best practices, loan submission and structuring processes, alternative methods for income calculation and more.

Lenders understand that this not only gives partners a competitive advantage with prospects, it also empowers these originators to educate their own referral partners — from financial advisors to Realtors — on the non-QM segment so that they can assist a wider range of homebuyers. At the end of the day, this dedicated approach to specializing in non-QM products (whether for a purchase today or for a refinance down the line) can help originators expand their base of high-quality borrowers.

Borrowers, too, want to make an educated decision, and they often choose their originator based on their confidence in the originator’s product knowledge. To capture borrowers’ attention and loyalty, originators must develop a new level of non-QM mastery. ●

The post Time to Hone Your Craft appeared first on Scotsman Guide.