Return of the non-conforming lender

Before the GFC, a typical non-conforming borrower would have had multiple defaults on their credit report or recent arrears on their loan statements.

It’s a different story today. As lenders and mortgage insurers have tightened their credit requirements, a borrower can have as little as one default on their record – a late payment fee on a telephone or utility bill for example – and still be considered non-conforming.

Self-employed borrowers in particular can find the lending environment tough, unable to meet standard lending requirements for a range of reasons such as employment term, cash out requirements and security type. Before the financial crisis, some of these self-employed borrowers would have been considered prime borrowers.

MKM Capital’s operations and marketing manager Michael Watson highlights the shift. He says many of today’s non-conforming borrowers are widely considered to be ‘clean’ borrowers – those whose “line of work can often lead to the odd default”.

“Similarly, ‘clean’ clients can be those with a lumpy income or property investors looking to spread their risk among a larger group of lenders,” Mr Watson says.

For example, property investors often want to divest an asset from their portfolio if their debt is too high – so they move one asset to a non-conforming lender in order to sell it in a controlled manner.

SUPPLY AND DEMAND

The expanded definition of a non-conforming borrower is a boon for specialist lenders, who are seeing demand for their products increase.

“The non-conforming market has grown significantly over the last three years, and at the same time the number of lenders in the market has reduced,” Mr Watson says.

But it is not just lenders who are reporting an increase in demand for non-conforming products. Brokers are also witnessing growing demand, thanks to tighter lending criteria by mainstream lenders.

According to a recent The Adviser weekly straw poll, 43.3 per cent of brokers have seen demand for non-conforming products rise over the last 12 months, while 32.7 per cent believe demand has waned. Of the 275 respondents, just 24 per cent felt demand had stayed the same.

More than 15 per cent of Top 10 Originator Better Mortgage Management’s new business volumes stem from non-conforming activity.

Better Mortgage Management managing director Murray Cowan says the non-conforming market continues to grow and he hopes the trend will continue.

“Due to tightening credit requirements from lenders and mortgage insurers, the scope of non-conforming borrowers has expanded. For example, prior to the GFC, mortgage insurers would usually overlook a paid default for a late payment of a Telco or utility bill if there was a reasonable excuse for the late payment and the amount was not large,” he says.

“However, today there is a zero tolerance policy among mortgage insurers which means many borrowers are now considered non-conforming with just one late payment in their credit report of amounts as low as $100.”

From a lender’s perspective, Mr Cowan says it is satisfying to be able to help non-conforming borrowers – who in many cases are traditional ‘prime’ borrowers – access finance and get their financial situation back on track.

But satisfaction aside, there are some obvious pitfalls brokers need to be mindful of when targeting the non-conforming market.

According to Mr Cowan, when assessing loan applications specialist non-conforming lenders are required to undertake a more detailed credit assessment. Moreover, settlement ratios are lower than prime loan applications.

When loans do settle, careful arrears management needs to be taken in order to ensure good conduct on each loan is maintained.

As such, brokers need to make sure they have all the facts before pushing ahead with a non-conforming loan application.

Pepper Home Loans’ executive director sales and marketing Duco Sickinghe suggests brokers first ‘test’ the non-conforming borrower’s situation with the lender.

“When dealing with non-conforming products, there are so many variables, so the key is to be as transparent as possible with the lender in order to find the best solution for the borrower in a timely manner,” he says.

Mr Sickinghe says brokers who deal with non-conforming borrowers should identify themselves as “solution providers rather than product finders”.

“A non-conforming borrower is looking for the best solution rather than the most competitively priced product,” he says.

According to Mr Sickinghe, there are not many competitively priced non-conforming products available.

But Janelle Rayner, executive director of Barnes Home Loans, says competitively priced products are not particularly important to non-conforming borrowers.

“With reductions in LVRs for low doc loans, good borrowers find themselves with nowhere to go. Specialist lending can provide an answer and we are finding that borrowers are willing to pay a little bit more to achieve investment goals,” she says.

PRODUCT CHOICE VS. POLICY

The definition of a non-conforming borrower may have broadened, but the choice of non-conforming products has remained fairly static.

Liberty’s chief operating officer James Boyle says while the range of specialist non-conforming products available has not changed over the last five years, non-conforming policy and the way it is applied has changed dramatically.

“Five years ago customers were able to borrow 100 per cent or more of the value of their home. Three years ago customers could declare their income, have no genuine savings and still get a home loan from their bank. But today, banks are constantly turning customers away,” says Mr Boyle. “If a customer is looking for great service, good pricing and consideration for their unique situation, a specialist lender is a much better alternative than a bank.”

RESIMAC offers a suite of specialist lending products including full doc, lo doc and lo doc plus products for borrowers with impaired credit, self-employed borrowers, and those wanting larger sized loans.

RESIMAC’s chief operating officer Allan Savins says although non-conforming policy has changed in recent years, there will always be demand for non-conforming loans – which is good news for specialist lenders.

“From our perspective at least, specialist products are anti-cyclical in nature,” he says. “That is to say, when times are good and demand is high, everyone will be writing business. However, when the wind changes and credit becomes more challenging, RESIMAC specialist lending will continue to write business.”

TARGETING THE NON-CONFORMING MARKET

Less than 20 per cent of borrowers have no credit impairments, which suggests there are plentiful and varied business opportunities in the non-conforming market.

Borrowers are also using non-conforming products for purposes other than property ownership, including debt consolidation, ATO bills, ATO debt and sourcing extra business cash flow.

So with demand for non-conforming loans at a new high, how can brokers’ best market their services to prospective non-conforming borrowers?

With rates on the rise, recent first home buyers are a good place to start. Ms Rayner says brokers should also start by revisiting their client database.

But when dealing with non-conforming borrowers, Ms Rayner says there are some fundamental rules for brokers.

“A broker should always ask their credit-impaired borrower three basic questions: what was the event that caused the credit impairment; how has the position changed; and what will be the benefit,” she says.

“The customer must be able to show that they have now rectified their situation and can service the loan and there must be a clear financial benefit for the borrower for the loan to be approved.”

Ms Rayner says it is important for brokers who deal with non-conforming borrowers to remember that they are not privately lending funds, adding: “the borrower must be able to demonstrate that they can afford the loan”.

“Non-disclosure is a definite no-no. Analysts go through these applications with a fine tooth comb and if they find something that has not been addressed, they will decline the loan with no further discussion.”

This being the case, Ms Rayner says it is a good idea for the broker to do their own credit checks before they submit the loan, allowing them to check the appropriate interest rate that pertains to that level of risk.

SPECIALIST BENEFITS

According to Ms Rayner, if a broker is open and honest with their borrower, they should expect the same in return.

If both parties are transparent, Ms Rayner says the pitfalls associated with dealing with a high risk borrower are outweighed by the benefits.

One such benefit is solid remuneration.

“Specialist lending is becoming increasingly important to the broker industry,” Ms Rayner says.

“Mainstream lenders compete with brokers in the prime space; however, a borrower will seek out a mortgage professional to access a specialist loan.

“Brokers will in general receive higher remuneration for these types of loans.”

It is for this reason, among others, that Graham Reibelt decided to target the non-conforming market.

The founder of Oasis Home Loans, Mr Reibelt says he gets a great sense of satisfaction from finding a solution for Australian borrowers who would otherwise not be able to achieve property ownership.

And with 90 per cent of his business generated from non-conforming borrowers, Mr Reibelt is adept at targeting this burgeoning market.

When targeting this market, he says it is prudent for brokers to listen to the borrower’s needs and provide a sympathetic ear.

“While non-conforming loans are generally short-term, if a broker treats their client with respect and care, they can be guaranteed of generating further business down the line through word of mouth,” he says.

TOOLS OF THE TRADE

Mr Reibelt says when dealing with non-conforming borrowers, there are a few trade tips he likes to adhere to:

• UNDERSTAND THEIR SITUATION – Not all home loans are black and white. Brokers need to be open to every situation. “Don’t judge the circumstance; instead, help your customer find a solution that suits the circumstance.”
• BE TRANSPARENT– It is imperative that brokers withhold nothing from their customer – “if you disclose everything, it is more likely that they will disclose everything to you”.
• LEAVE PRICE ALONE – Non-conforming borrowers are not prime borrowers and cannot pick a product solely based on price. “You are selling your customer a solution, not a product. So don’t even talk about price until you have found the best solution for their needs.”

THE TIME IS RIGHT

Thanks to the GFC and mainstream lenders’ growing aversion to risk, Mr Reibelt says now is a good time for mortgage brokers to target the non-conforming market.

“The GFC really has been a blessing in disguise for brokers that target non-conforming borrowers. Borrowers that were once prime banking customers are now going in search of non-conforming products, simply because they fall just outside of the majors’ desired mould,” he says.

“There [are] currently more non-conforming borrowers than ever before and the quality of applicants is better than ever.”

Mr Reibelt says brokers who do not want to target the non-conforming market directly may prefer to establish a referral partnership.

“Recognise your skill set. If you don’t feel comfortable servicing the needs of non-conforming borrowers, then a referral partnership may be the better option – and it could also have a beneficial impact on your bottom line.”

Sound advice indeed.