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ALTERNATIVE-A LENDING
In the early to mid 1990's a new product emerged in the mortgage industry. It was a loan based solely on the credit of the borrower and the collateral, with income and assets “not verified”. This product was known as the “NINA” (no income, no asset) loan. The mortgage lenders who specialized in this product became known as “ALTERNATIVE A” lenders, later shortened to “ALT-A”. Since 1999, many billions of dollars of Alt-A securities have been issued. Investor acceptance of, and demand for Alt-A securities has been fueled by the participation of Fannie Mae and Freddy Mac in this sector. In the past, investors in these securities relied almost universally on the credit score ranges contained in the mortgage pool as the indicator of expected performance. As the growth of this market continues, characteristics of the securities have broadened. Investors must now look at a range of factors to determine minimum risk. These include:
1. The types of collateral: single family residences, 2-4 unit properties, garden condos and high rise condos, planned unit developments (PUDs); 2. Occupancy types: owner occupied, second homes and investment properties; 3. Product type: fixed rates, arms, balloons; interest-only options; 4. Purpose: purchase or refinance loans; 5. Loan size; 6. The presence or absence of prepayment penalties; 7. Loan to value: from 100% and below.
Types of Alternative-A loans have also evolved. Where once the product was only a “no income” verification loan, a true “NINA” emerged. Eventually certain lenders offered a complete “No Doc” loan, which required no employment, no income and no asset verification. Hybrids later developed. “No Doc with verified assets” means that no employment information or income is provided, but assets are verified. “LISA” loans are loans that contain “light” income verification and “stated” assets. Documentation for this type of loan is typically twelve months of personal bank statements (or twelve months of business bank statements if the borrower is self-employed) and stated, not verified, assets to close. Another hybrid is known as the “FISA” loan, full, verified income with stated, not verified assets. Pricing of these loan types varies depending upon the perceived amount of risk. Loans that contain more verification are priced more favorably than loans with little or no information verified such as No Doc. Alternative-A mortgage securitizations are analyzed and rated by a number of factors, including product with different levels of documentation, different property types, credit score ranges, mixed amortization types, varying repayment terms, loan size and geographic distribution of collateral. Performance characteristics of the securities are measured by delinquency, default, prepayment behavior, loss severity and cumulative losses. Interest in these securities expands as investors begin to have a better understanding of expected performance.
Who is the Alt-A Borrower? Traditionally ALT-A borrowers are A-credit rated, but associated with characteristics that make them ineligible for traditional conforming or agency (Fannie Mae, Freddie Mac, FHA and VA) lending programs.
Credit Since income and assets are typically not supported, credit history and depth are important indicators of the borrower’s ability and willingness to repay debt. In most Alt-A underwriting, lenders are looking for at least two years history of managing credit successfully and having at least five trade lines reported by the credit agencies. Another important indicator is having current housing expense. The manner in which a borrower pays his current rent or mortgage is considered a strong indicator of how he/she will handle the new mortgage payment. The underlying credit quality of a borrower is typically measured by his credit score. Although there can be a wide range of credit score “buckets” in the Alt-A lending programs (i.e.580 and above) most borrowers have A rated credit (640 and up). There is a strong correlation between credit scores and permissible loan to value ratios. Generally the higher the score, the more credit worthy the borrower is, and the higher the permissible loan to value. Not only is depth of credit and credit score considered, but also late payments or delinquencies will be taken into consideration. For example, most Alt-A lenders look at the mortgage or rental history for the past twelve to twenty-four months. At certain higher LTVs, there can be no late payments reported on the mortgage account within the past twelve months. Generally speaking however, late payments on consumer credit, installment and revolving loans, will not be considered in the credit grade at LTVs of 90% or lower. Judgments, collections, charge-offs, repossessions, and other credit related liens can be indications of serious problems and applicants with items such as these on their credit reports will not fit into Alt-A or conventional underwriting guidelines. An exception to this policy would be medical collections, however these usually must be paid off at closing. Bankruptcies and mortgage foreclosures generally follow conventional underwriting guidelines which state that the borrower can not have had a bankruptcy in the past two years or a foreclosure within the past three years.
Assets: Under conventional underwriting guidelines, the borrower is expected to prove that he has the funds available for the down payment, closing costs and reserves. A NINA borrower is not required to verify the cash needed to complete the transaction. Instead, simply “stating” required assets on the mortgage application, or leaving the assets section of the loan application blank, will be sufficient.
Employment: While income is not verified on Alt-A loans, employment is verified. Lenders offer loan programs for salaried, self-employed, and retired individuals. In some cases lenders offer a NO DOC loan wherein employment is not even required to be stated. Guidelines vary, but typically lenders require two years of employment in the same line of work if salaried, or two years in the same job if self-employed. Underwriters will take into consideration an individual who has perhaps just finished college with a degree and is starting to work in a professional capacity. Therefore, a borrower who has just a few short months on a job may be eligible for a NINA loan if he can prove that he has been preparing for this position in college.
Risk Based Underwriting. Alternative-A loans are underwritten utilizing a “risk based” approach. Because levels of documentation vary, the essential requirement of prudent underwriting is that the terms of the loan be directly related to the borrower's probability of repayment and the value and marketability of the mortgage collateral. This is unlike conventional underwriting which is based on credit ratio requirements for housing expense and other total debt to income ratios, and where repayment can be predicted in a more precise manner. In these loans, employment, income, and assets are verified and clearly known to the underwriter. Because of the various levels of documentation and verification in Alt-A underwriting, loan characteristics tend to be directly related to one another. For example, a borrower who has a high credit score will likely be granted a higher loan to value than a borrower with a lower score. A property that can be compared with very similar properties to determine market value, as opposed to a property requiring large adjustments due to dissimilarities, will allow for a higher loan to value. If two borrowers have similar credit scores, but one borrower can verify assets and the other cannot, the verified assets loan will be looked upon more favorably. Not only will a higher loan to value be considered, but the loan amount could also be higher. Alt-A underwriters will often refer to “layers of risk.” Typically each layer of risk will be met with a pricing “add-on.” For example, a low credit score may be given a 25 basis point price adjustment. A high loan to value may be given another 25 basis point adjustment. Investor properties, as opposed to owner-occupied properties, will likewise be adjusted. Each layer of risk (low score, high loan to value, non-owner occupied properties) is subject to a pricing adjustment to compensate the lender for the increased risk.
Alternative-A Case Scenarios Here are a few typical scenarios where a borrower would be a candidate for an Alt-A loan.
Case # 1: Bob Smith has been a waiter for five years. In this time he has worked for three different restaurants, with no time off between jobs. Since the largest part of his income is from tips, of which only a portion is reported, he does not have an acceptable debt to income ratio based upon verifiable income. Bob has rented in the same apartment complex for the last three years and pays monthly rent of $800. He has always paid rent on time and the lender will be able to obtain an excellent verification of rent from his landlord. Bob has found a condo that he wishes to purchase for $150,000. He has a bank account totaling $5,000 and knows that his father has promised a gift of $20,000 to purchase a home. Bob also keeps cash in his apartment of approximately $2,000, so he knows he will have enough funds to purchase the home, but he cannot verify that all the funds needed to close are 'seasoned' in the bank. In addition to paying his rent on time each month, he has maintained good credit for several years, with the exception of a 30-day late on his car loan several months ago. He has 6 trade lines on his credit report and a credit score of 651. Bob makes a mortgage application with his mortgage broker for a 95% loan. His broker advises him that he needs to consider a NINA loan because he cannot verify his income or his assets. On the loan application no income is stated and assets are “stated” $27,000. The loan is approved with an Alt-A lender. His credit score of 651 qualifies for 95% financing. The one time late payment on his installment is overlooked because of his good overall credit.
Case #2 Sally Score is a schoolteacher, working at the same school for four years. She has been living with her fiancé for the last two years in an apartment that they rent. Sally has excellent credit with a score of 695 and has six years of strong credit history with many trade lines and very few consumer credit late payments. She and her fiancé wish to purchase a home valued at $350,000. Her fiancé has an excellent job and a high income and can easily afford the mortgage payments but has had credit problems in the past and has very low credit scores. There is no way that he can be a co-borrower on this loan. They wish to put down 10% and most of the down payment is in the fiancé’s bank account. They will both occupy the new home qualifying them both as owner occupants for underwriting purposes. Sally makes an application with her mortgage broker, explaining the details of her situation. The mortgage broker suggests a NINA loan, with Sally as the only borrower. In this case, although the employment is verified, the income section of the loan application is left blank, because if income were stated, it would have to make sense, or be reasonable. Generally it would not be deemed reasonable to think a teacher could support a mortgage loan in the amount of $315,000. The approval of credit will be based solely on her score. Additionally, assets are stated, not verified. The lender approves the loan and Sally and her fiancé move into their new home.
Case #3 Charles and Barb have owned a hair salon in New York for many years and have a strong client base and a very successful business. They have managed to save over $250,000 and decide that they would like to move to a warmer climate. They sell their home in New York and move to Miami, Florida. Because they are so knowledgeable in the salon business, they rent space in a very chic area of Miami Beach and set up a beautiful salon. They find a home they wish to purchase and go to a local mortgage broker to obtain a mortgage. Charles and Barb each have excellent credit scores, well above 700, and they have ample funds for a 10% down payment. Because they have years in the same line of work they anticipate no problems obtaining a loan. However, their mortgage broker sees the situation differently. True, they have been successful, self-employed salon owners for many years, but a salon is strictly a client-based business, and being new to the area they do not have an established client base that will provide a stable income stream. The broker suggests a “No Doc with verified assets.” They are approved for the mortgage and close on their new home. The philosophy behind an Alt-A loan is that there is a loan for every borrower. Alt-A lending is not sub-prime lending, but rather, lending that offers alternatives to “conventional” guidelines. This is a very big distinction in the respect that sub-prime loans are priced to take into account the added risk of lending to borrowers who may have a higher propensity to default. Alt-A borrowers have proven their willingness to repay their loan obligations over time, which translates into much better pricing for them.
Advantage Financial Funding Corp. - The Commons at Lincoln Center - 124 John Robert Thomas Drive - Exton, PA 19341 Office Phone: (610) 594-8880 Fax: (610) 594-6884 Toll Free Phone: (800) 578-8400 Licensed and Regulated by: Pennsylvania Department of Banking Pennsylvania Department of Insurance Pennsylvania Real Estate Commission 
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