It’s now obvious: the mortgage lending industry is forever changed. Here’s what happened — and what’s likely to come next.
The Year of Minimum-Risk Lending
Back in April 2020, we noted that mortgage lenders were getting tougher on loan applicants. Perversely, the borrowers who stood to benefit most from the low interest rates that led to a refinancing boom were the ones who faced the highest barriers to access. Lenders scrutinized any changes in applicants’ work lives, income and credit profiles, looking for signs of instability.
Banks are traditionally uncomfortable with non-salaried applicants and volatile income streams. Without a continual stream of W2 wage income, applicants are often considered too risky. Some mortgage companies simply stopped working with applicants outside the Qualified Mortgage (QM) category in 2020. Even the companies that had, pre-pandemic, used their professional discretion to help viable borrowers. Even the ones that specialized in out-of-the-box loans.
By mid-2020, conventional loan buyers Fannie Mae and Freddie Mac were telling self-employed borrowers to submit detailed year-to-date data to lenders. Freddie directed lenders to “review the YTD profit and loss statement…business account statements, and all other relevant factors and documentation to determine the extent to which a business has been impacted by COVID-19.” And while the Federal Housing Administration did not change its loan criteria, borrowers got shut out of FHA mortgages anyway. Mortgage companies had raised their own minimum credit scores. And they were taking extra precautions to avert risks of fraud amidst a disturbing new reality that took hold in 2020.
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Today, a year after the lockdowns started, home loan interest rates are climbing out of their pandemic-year lows. Many hopeful home buyers are losing their chances to get a low-interest loan. In this seller’s market, they can’t afford to buy a home.
On a positive note, the housing market did not come apart as some had feared it would. And there are multiple signals that borrowers will see better days ahead. Specifically, rapid advancements in technology, coupled with more flexible borrowing criteria, will make mortgages accessible to more people.
The Rise of the “Outside-the-Box” Mortgage Applicant
The traditional work week is no longer the broad status quo. Our new reality is different. Some home buyers and owners have been out of their normal work patterns for more than a year. Some have changed fields or started up internet-focused businesses.
Some took up day trading in the stay-at-home months. Still others jumped headlong into the gig economy. The Bureau of Labor Statistics shows the populations of gig income earners added up to more than a third of the U.S. workforce by the time the pandemic hit. Now, their numbers are expected to rise much higher.
The dislocations of 2020 resulted in income losses for some people. For many more, they created nonstandard borrower profiles. How serious are all these factors, taken together? Consider this. By late March 2021, according to Redfin data, home sale prices were up a whopping 16% from the year before. Homes now sell at a record-setting $331,590 median, with more than a third of going for more than their listing prices. A logical inference? Some potential home buyers must delay their goals. They need the financial strength to obtain increasingly larger mortgages.
So, lender flexibility is necessary to accommodate the rising tide of workers, in an expensive market, who will not submit W2s and pay stubs. Don’t forget to add the emerging era of robotics and automation to the mix. In August 2020, Time ran a story under the headline Machines and AI Are Taking Over Jobs Lost to Coronavirus. Need we elaborate?
The Return of Flexible Loan Criteria
For conventional loans, applicants have long had to produce pay stubs, employment verification, tax documents, and bank account data. But many of today’s borrowers have a different portfolio of income proof. Lenders will need to recognize new types of data. They will need to know how to verify them, too. New sources of data could be downloads from gig economy agencies’ platforms, PayPal account statements, and 1099s for independent contract work.
Today’s self-employed workers may itemize their business expenses to lower their taxable income. Loan underwriters have generally wanted to see as much income as possible, but it’s important for lenders to acknowledge rational, tax-focused decisions, and update the way they calculate income.
Especially after a year-long burst of displacement, many working-age people could never buy a home if lenders insist on rigid loan criteria. Sure, a lot of people are buying homes and keeping the demand high. But the playing field needs to be fairer. Underwriters need to look at nonstandard work histories and cash flows in a new light. To start, as Jeff Ostrowski at Bankrate observes, we are already seeing the return of non-QM loans for self-employed borrowers and others in nontraditional work situations.
Looking ahead, affordable housing policies are express priorities for the Biden administration. “Increased government spend on affordable housing would be a net win for lenders,” says Sipho Simela for MReport, because it will draw more people to apply for loans. If 2021 trends continue, mortgages that were once in the margins will be moving into the mainstream.
Digital Future: A Genie Who Won’t Be Rebottled
After economic dislocations, more people are likely to start putting their homes up for sale to tap the value locked in their real estate. We can expect many buyers to enter the market, looking for first or second homes in the condo market and mobile home communities. User-friendly loan application methods have never been more needed.
People also want financial experts to understand their circumstances. They want open and transparent dealings. This is especially so with Millennials and Gen Z borrowers. As the Credit Union Times suggests to industry leaders:
Acknowledge the fact that little or bad credit is often unavoidable during a crisis like this and talk about the alternate ways your credit union determines creditworthiness. This kind of transparency and compassion will likely result in some lifelong members.
The financial sphere has ramped up its adoption of digital tools during the past year, and that will make a positive difference. Digital services can make mortgages more understandable and more accessible. The convenience of the digital mortgage, for example, is a genie who won’t be rebottled.
For further examples, the Federal Housing Finance Agency has green-lighted remote online notarization (RON) for mortgage paperwork, and the Mortgage Bankers Association and the American Land Title Association have done the same for deeds. Digital documentation and remote signing techniques simplify home buying. They also help keep everything together in accessible portals — not delayed in the mail or lost in a drawer. Tech innovations also permit home buyers to compare and contrast prices, terms and conditions, and customer reviews. The result will be customer empowerment. And we can expect property tech to continue its rise, given the leaps taken in offices to communicate and exchange goods and services during the pandemic.
All in all, we expect to see the mortgage sphere integrate more technology, come to grips with nontraditional applicants, and offer opportunities for more people to reach their home buying goals. In these trying times, it’s good to find some inspiring trends.
Freddie Mac: Selling Guidance Related to COVID-19 (Bulletin 2020-44; Nov. 13, 2020).
Freddie Mac: COVID-19 Selling-Related Frequently Asked Questions (updated Mar. 11, 2021).
Daryl Fairweather (Chief Economist, Redfin): Five Ways the Housing Market Will Change After the Pandemic (Mar. 31, 2021).
Sipho Simela for MReport. Mortgage Lending Best Practices: How the Goalposts Are Shifting (2 Apr. 2021).
Jeff Ostrowski for Bankrate. As Housing Rebounds, Non-QM Mortgages for Business Owners Make a Comeback (Sep. 22, 2020).
Clint Salisbury for AmericanBanker.com. Opinion: For Mortgage Lenders, Changes Driven by the Pandemic Are Here to Stay (Mar. 26, 2021).