Alternative lending has officially become mainstream and that’s good news for underserved markets
The home loan market has seen a significant shift over the last few years from traditional lenders to alternative, non-bank lenders. Fintech and technology companies have moved in to disrupt the space alongside the traditional players. Alternative mortgage lenders now account for almost half of all home loans, according to the Federal Reserve. There has been 700% growth in the marketplace lending industry in just four years and this growth is expected to continue according to American Banker
More homeowners are turning to alternative, non-bank lenders especially in traditionally underserved markets. Folks that don’t check the standard underwriting boxes are looking for alternative lending options and non-bank lenders have been capturing market share due to the value they bring to underserved consumers.
Chris Aldridge of DRI Fund, an expert in performing loans, explained to us what’s behind this change and how it’s playing out for borrowers.
The reason for a shift in the market:
100% Compliance: Banks started to withdraw from the lending market due to a shift in regulations after the financial crisis. Dodd Frank and related regulations have new compliance rules that require 100% compliance. Furthermore, the Consumer Financial Protection Bureau is strictly enforcing these regulations. Complaints or accusations of non-compliance can spur an investigation from the CFPB that may result in significant fines or litigation. In response, banks have tightened their lending standards to those that clearly fit automated lending programs. This facilitates “check the box” underwriting, documentation and incontrovertible evidence of ability to pay like W-2 income and term of employment. Unlike big banks, alternative lenders are able to focus on the full picture of an applicant and lend to worthy applicants that might not check all the boxes.
The Gig Economy: At the same time that banks are tightening regulations, the evolving structure of our economy has resulted in more families with 1099 income, frequent job changes that use non-traditional sources of credit. The days of having the same job for 30 years is over and freelance employment is becoming the norm. The gig economy is expected to grow significantly over the next four years. “The gig economy…is now estimated to be about 34% of the workforce and expected to be 43% by the year 2020,” Intuit (INTU) CEO Brad Smith. That means 9.2 million Americans are expected to work in the gig economy by 2021, up from 3.8 million last year, according to combined research by Intuit and Emergent Research. As a result, each year more and more of the population moves away from the traditional lending standards, income documentation and towards metrics for willingness or ability to pay.
Who are some of the players in this space?
Online Lenders: The first segment are those online mortgage lenders that serve the prime conforming market and compete with banks. Quicken Mortgage and PHH Corporation are the two largest. These companies rely on technology to speed up the lending process and generate huge profits through smaller margins and huge scale. Today, Quicken is the nation’s second-largest retail residential mortgage lender. Quicken also has launched a Rocket Mortgage platform that provides a mortgage department for banks that want to provide their clients with mortgages, but want to avoid the regulatory process. The compliance and documentation processes are more costly, but most believe that they have identified alternative metrics that demonstrate their client’s ability and willingness to pay. They offset these costs through a combination of higher fees and higher rates. These loans typically wind up in securities sold to long term investors or are sold to institutional investors as whole loans on a pooled basis.
CDFIs: There are also Community Development Financial Institutions that are certified by the Treasury Department whose mission is to serve underserved markets. CDFIs, find ways to develop affordable financing programs and provide additional homeowner education and counseling services. CDFIs will look at alternative sources of credit history and income to make common sense loans that help people, who may need a second chance, achieve the dream of homeownership. Rates and down payment will be dependent on the loan characteristics. DRI Fund is one example of a CDFI. DRI Fund’s lending programs are designed to provide a long term positive impact. Clients are provided with HUD Certified financial counseling through partner agencies to make certain that the biggest financial decision in their life is well thought out and actually improves their long term financial stability. That critical element distinguishes a CDFI from lenders driven by pure profit motive.
Bottom line. Home buyers who don’t fit the standard underwriting box now have options to obtain financing – it just may not be through mainstream banking.