In the last three years, some lenders have expanded the market for prime-credit, low-documentation mortgages by raising permissible loan-to-value (LTV) ratios and lowering credit score requirements. Now reports are surfacing that these loans are not performing well. Yet, some types of primecredit, limited-doc loans outperform full-documentation loans.
THE MORTGAGE MARKET IS INTENSELY COMPETITIVE, and companies battle it out fiercely over every nook and cranny in every niche the market has to offer. That means lenders will always be pushing to see what the limits might be for any given product to see if they can expand the market for that product or group of products. * In the area of prime or A-credit, limited-documentation loans--the so-called alternative-A market--the innovators may have gone about as far as they can go. * Some of the products offered in the market in the last three years in the 80 percent and higher loan-to-value (LTV) segment are starting to season enough to show seriously higher defaults, foreclosures and claims. Loan performance problems are, in fact, occurring for some products in the alt-A market at a pace four to five times greater than for full-documentation, prime-credit loans, according to mortgage insurers. * One of the more troublesome loan types in the alt-A market is the no-income, no-asset (NINA) loan. With the NINA loan, borrowers do not have to state their income. Nor do borrowers have to state what their assets are. As a result, the borrower does not have to produce documents showing any income and/or assets. Usually, the borrower must state the name of an employer, the address of the employer and the type of job the borrower has--all subject to verification. Other than that, the decision to approve the mortgage rests almost entirely on the borrower's credit scores and the appraised value of the home.
Another niche loan program, the stated-income loan, also has run into some performance problems. For this loan, borrowers simply state their income, but do not have to provide verification of the income level. Usually, stated-income borrowers list assets, which can be verified by the mortgage lender.
The alt-A market is generally defined as loans made to borrowers who meet Fannie Mae and Freddie Mac underwriting standards for credit score, but that incorporate flexibility beyond agency guidelines for documentation requirements, property type, debt ratio or LTV ratio. These borrowers typically pay a small premium for that flexibility.
Alt-A loans with 80 percent and higher LTV ratios were widely available in the late 1980s and early 1990s, but those loans performed poorly in the early and mid-1990s. As a result, underwriting standards were tightened, product offerings were withdrawn and the market mostly evaporated. (This was not true of the segment of the alt-A market for loans with LTVs below 80 percent, which is discussed later. Low-LTV alt-A mortgages continued to perform well during the mortgage industry downturn of the early 1990s.)
The alt-A market for higher LTVs (above 80 percent) was reborn in 2001, and is now in the fourth year of strong origination growth. Unfortunately, there are no nationwide numbers on the size of this market, although mortgage insurers report it has remained strong and represents a significant segment of their business.
In an age of steadily rising house prices and extended refinancing booms, low-documentation loans offer more flexibility and less overall hassle for borrowers, who do not have to supply the verifications of income, employment and assets required with a full-documentation loan. On the other hand, some low-doc loans can carry a higher risk of delinquency, default and foreclosure.
The evidence of poor performance is beginning to show up in analyses done by mortgage insurers, who cover a portion of the loan loss on defaults for loans above 80 percent of the original appraised value.
United Guaranty Corporation, a mortgage insurer based in Greensboro, North Carolina, reports that for a period of 2 3/4 years--from January 2001 to the end of September 2003--the default rate for NINA loans that it insures was 5.07 percent. That is sharply higher than the 1.59 percent default rate for full-doc loans.
Similarly, the claim rate for NINAs was 0.53 percent, compared with 0.12 percent for full-doc loans during the same period. United Guaranty has nearly 8,500 loans in its NINA portfolio, according to Kurt Smith, vice president for risk management at United Guaranty Residential Insurance Co., the subsidiary at United Guaranty that offers mortgage insurance.
Higher defaults and claims on NINAs are not entirely unexpected, according to Smith. "NINA has always run ahead of other limited-doc in providing an early indication of problems," he says. For example, in 2001, when the number of NINA loans began to be a significant part of United Guaranty's low-doc business, delinquencies were running at 9.7 percent--twice the overall delinquency rate for the universe of loans with similar seasoning, Smith says.
NINAs now represent about 20 percent to 25 percent of what United Guaranty calls its limited-doc business, Smith says. (United Guaranty does not call this segment its alt-A business, as it does not include such products as very high LTV cash-out refis, which some lenders include in the broad definition of alt-A.)
By comparison, he adds, stated-income loans represent 60 percent to 65 percent of United Guaranty's limited-doc business. Stated-income loans require the borrower to state his or her income level, but the borrower does not have to document that with pay stubs or, in the case of the self-employed, with tax forms. Usually, stated-income loan borrowers do report and often verify their assets.
For United Guaranty, the low-doc stated-income business has actually outperformed its prime-credit, full-documentation business. This is thanks to the fact that lenders have limited the loans to applicants with higher average FICO[R] scores than is the case for most A-credit loans.
From early 2001 to the end of September 2003, for example, stated-income loans insured by United Guaranty had a default rate of 1.20 percent, compared with 1.59 percent for full-doc loans, according to a company spokesperson. The...