Nonbank lenders, including credit unions and other small, community lenders not associated with banks, are making riskier mortgages – mainly Federal Housing Administration (FHA)-insured mortgages – with increasing frequency, according to the Los Angeles Times. Currently, nonbank lenders issue 64% of FHA-insured and Department of Veterans Affairs (VA)-guaranteed mortgages.
Nonbank FHA-insured mortgages are 23% more likely to go into default than FHA-insured mortgages issued by banks. However, while 23% sounds significant, it’s only the percentage difference between 0.9% of bank-issued mortgages in default compared to 1.1% of nonbank-issued mortgages in default.
Part of the reason for the 0.2 percentage point higher default rate for these mortgages is that nonbank lenders apply looser lending standards to borrowers seeking FHA-insured financing. FHA-insured mortgages have significantly lower qualification standards which allow struggling buyers to obtain financing with minimal down payments and lower credit scores.
Although held to the same minimum FHA underwriting standards as banks issuing FHA-insured financing, nonbank lenders may be more likely to underwrite mortgages closer to the absolute minimum qualifications. This means nonbank lenders are slightly increasing the risk of default on their FHA-insured originations by lending to more vulnerable borrowers.
Not the return of subprime lending
Some fear that nonbank lenders – who participated in no minor way in subprime lending – issuing minimum-qualification mortgages are signaling a return to the devil-may-care standards which led to the housing crash. However, FHA-insured mortgages, although much looser than a mortgage issued on a purchase with a 20% down payment, are not necessarily subprime.
FHA-insured mortgages are increasingly the mortgage-of-choice for today’s financially restricted first-time buyers. FHA-insured financing assists buyers who’ve struggled with stagnant wages and student debt to accumulate enough personal savings for a down payment, bridging the savings gap to homeownership. However, these mortgages still come with additional costs, and buyers need to be aware before taking the plunge.
Buyers making down payments of less than 20% are required to have mortgage insurance coverage to protect the lender if the buyer defaults. FHA-insured mortgages require buyers to pay mortgage insurance premiums (MIP), which for a 30-year fixed rate mortgage (FRM) might equal 0.80% – 0.85% annually on the principal balance over the life of the loan.
The only alternative to the FHA’s MIP when a buyer has less than 20% to put down is a conventional mortgage with private mortgage insurance (PMI). However, PMI usually has stricter qualification standards and requires a slightly higher down payment in exchange for its lower monthly payment rates.
Ideally, buyers avoid the additional annual MIP/PMI homeownership cost by making a 20% down payment or more when purchasing a home. The cost savings by eliminating the MIP/PMI is equivalent to about 3.7% annual rate of return on the down payment. But for those who aren’t able to pull together the resources for such a substantial payment, FHA and other minimum qualification mortgages are their best bet for buying a home.
The FHA has not given any sign of concern for nonbank lending practices to date. Real estate agents just need to make their buyers aware of the total costs of FHA-insured minimum-qualification mortgages, and ensure they are financially prepared to make payments and avoid default. As for the weakest buyers, refer them to their neighborhood credit union or small community bank for the mortgage they need.
Re: “After subprime collapse, nonbank lenders again dominate riskier mortgages,” from the Los Angeles Times