Some of you may recall the financing options available in the few years leading up to the housing bust. If you could fog a mirror, you got a loan! For example, you could get 100% financing on an interest-only mortgage, even if you were just 1 day out of bankruptcy. Needless to say, such lax requirements led, in large part, to the historic housing collapse, and credit has been reined in considerably. That being said, there is a place for non-traditional mortgages, although it is a highly misunderstood niche.
Traditional vs Non-Traditional Financing, In Summary
When we say “traditional” financing, we normally refer to Conventional, FHA, VA, and USDA loans. These types of loans are overseen in some way by government institutions (or quasi- government institutions!) to ensure that borrowers meet certain criteria. These criteria cover how much can be borrowed, the amount of the down-payment (or equity that needs to be in the home), credit scores, income, etc., but they also cover how this criteria is documented. You may be a self-employed borrower that makes plenty of money, but you don’t show much on your tax returns. Non-traditional financing is not overseen or regulated in the same ways and therefore has more flexibility in setting guidelines and requirements. The trade-off is the interest rates for non-traditional financing are often higher and they may have some non-traditional requirements (because they assume more risk). Non-traditional financing usually comes from groups of investors that are willing to lend in riskier situations, in return for higher returns (interest rates). It’s more fluid than traditional mortgage lending; it’s like borrowing money from a rich aunt instead of the bank. She can make exceptions that a bank can’t, but she may have some different requirements.
Benefits of Non-Traditional Financing
Non-traditional financing has many names, but it’s very commonly referred to as “Alt-A”, so that’s what I’ll use moving forward. There are all sorts of Alt-A lenders serving different “niches”, but here some common uses/benefits of/for Alt-A loans:
· Non-documentable Income – Alt-A is an option for borrowers that don’t or can’t show much income. As previously mentioned, self-employed borrowers often have this problem. Or, if perhaps you work on a cash basis, you can use your bank accounts to offset what you don’t have in income (how it is counted varies). You often don’t need to provide tax returns or paystubs and retirement accounts can even be used (with restrictions).
· Recent Major Credit Problems – Traditional mortgages all require significant waiting periods if you’ve had a bankruptcy, foreclosure, or short-sale. Many Alt-A lenders will let you get a loan one day out of these events, which can be a huge advantage if you want the benefits of not renting for 3+ years.
· Non-warrantable Condos – Some PUDs (condos/townhomes) can’t get financing from traditional loans because they are non-warrantable (usually because there are too many renters). This is a very common occurrence, unless the HOA is on the ball. Many Alt-A lenders will lend against these non-warrantable properties.
Cons of Non-Traditional Financing
Before you jump into an Alt-A mortgage application while the ink on your bankruptcy paperwork is still drying, you’ve got to know the flipside of Alt-A loans.
· The rates are higher – Traditional mortgages will yield an interest rate (as of this blog post) of about 4.00% (for a 30-yr fixed, conventional). Comparable Alt-A loans will have interest rates of around 6.50%. For a $200,000 loan, that’s a payment difference of about $300/month.
· They require substantial down payments/equity – The smallest down payment requirement I’ve seen for Alt-A loans is 25% (a 75% loan-to-value ratio). The average is about 33% down and can be as high as 50% down (for people that are 1 day out of foreclosure). That’s just not an option for most people (especially if you just foreclosed!).
· They have larger loan requirements – Many Alt-A lenders won’t consider you if your loan is under $200,000. Traditional mortgage lenders often have incentives for larger loans, but Alt-A lenders often only do larger loans.
When Would You Use an Alt-A loan?
You may have seen a theme here: Alt-A loans are meant for people that get big loans, can put down large down payments (or have lots of equity), and/or have padded bank accounts. But, there are applications for those of more average means.
· Getting a good deal on a house – Even though you’ll pay more in interest, if you can get a good deal on a house, the equity you gain can often offset the extra you’ll pay in interest. You can also refinance out of the Alt-A loan when you can better qualify for traditional financing.
· Buying an investment property – If you have the cash (even in a retirement account, which sometimes can be used without tax penalties) but can’t show the income, an Alt-A loan can be a good way of picking up a rental or other investment property.
· Not having other options – As we have tirelessly tried to emphasize, owning is almost always better than renting, even at a higher interest rate. Some of you may remember when 6.50% was a deal, it’s still lower than the historic average of 30-yr mortgage rates.
As a mortgage broker, we can offer Alt-A loans from a multitude of lenders in addition to our extensive portfolio of traditional lenders. We often find that there are indeed traditional financing options available for you (which are preferable) instead of the initial intention of getting an Alt-A. We’re happy to talk about your situation and options with you and find the best way to achieve your goals.
