ARE THEY HERE TO STAY?

by Matt Woods
FORBES REAL ESATE COUNCIL

Unconventional loans are making a comeback, allowing borrowers with undocumented income streams to achieve their dreams of homeownership. While there are many benefits brought around by this trend, it’s also important to consider the potential risks before determining if this method is the right fit for you.

It’s no surprise that applying for a mortgage typically involves a lot of paperwork. Namely, mortgage underwriters need to see a well-documented financial history — including pay stubs and tax forms — to verify a steady stream of income. Or at least, that’s how it’s always been in the past.

Unconventional mortgages provide alternatives for those who don’t meet the standard income documentation requirements. For example, many software engineers contract their work, and while engineers who have been contracting for several years can easily document their income using tax returns, those early in their careers may lack the evidence of a steady income that is often required when trying to obtain a loan. Similarly, entrepreneurs can benefit from unconventional mortgage offerings, as self-employed folks often face challenges getting loans due to high risk of business failure.

Simply put, for those unable to provide employer pay stubs or a lengthy financial paper trail, unconventional mortgages allow individuals to simply provide alternative methods of verifying cash flow or assets requisite to getting a loan approved.

A History Of Unconventional Mortgage Loans

Unconventional loans have come with their share of criticism. Many experts believe they exacerbated the housing crisis of 2007 and 2008. And yet, with demand for homeownership on the rise — and with more and more Americans working nontraditional jobs — these loans are back in a big way. In fact, lenders issued more than $34 billion of these unconventional loans in the early part of 2018 alone (paywall), a 24% uptick from the same time period a year earlier.

The controversy over these unconventional loans has stemmed from borrowers misstating their income levels and lenders failing to do their due diligence or ask for the proper documentation. On the flip side, mortgage lenders I know say that these unconventional loans are much safer today and have been overhauled to allow for a higher level of scrutiny and security.

Practical Application

Despite the fact that the majority of Americans have easily documentable income and good credit, there is still a substantial segment of the population who don’t fit in the traditional “box” when it comes to lending criteria. Some have had unexpected events transpire in their lives that have negatively impacted their credit, such as with medical bills or the temporary loss of income. Additionally, there are millions of workers with alternative employment arrangements outside of receiving a steady paycheck from an employer. This segment of the population often has a hard time qualifying for a traditional mortgage. Thus, the industry has adapted to create loans for these kinds of circumstances. Here are some practical examples.

• Seasonal or commissioned income that varies throughout the year: This may include individuals in industries that are heavily dependent upon seasons or holidays, such as tax preparation, wedding planning, landscaping, snow removal, etc., where income may wax and wane throughout the calendar year.

• Medical bills are the leading cause of bankruptcy, affecting over a half a million families each year: Many people don’t realize that their health insurance may not be enough to protect them from financial hardship. Some lenders are adapting their guidelines to be more forgiving for such cases, allowing borrowers to refinance or purchase homes despite having a recent bankruptcy in their credit history.

• Borrowers who have significant assets, but don’t show sufficient documentable income: An example might be an individual who is out of work, but has sizable investments that can be drawn upon at will. Some lenders have programs designed to account for the fact that a borrower could easily repay the loan by liquidating such assets.

Unconventional Loans: Here To Stay?

Despite criticisms, it doesn’t appear that unconventional loans will become obsolete any time soon. They have been popular with smaller, specialty lenders, and now traditional mortgage brokers are getting in on the action, viewing it as a significant new source of revenue.

It’s important to note that these unconventional loans don’t typically meet the criteria to be backed by Fannie Mae or Freddie Mac. Many are fairly large relative to the documentable income of the borrower, and some span longer than 30 years.

These may seem like red flags, and certainly, caution is always good when seeking a major loan. But for those who have undocumented income and want very badly to own a home, there are options available — and those options are only gaining prominence. In our gig economy where consumers utilize services like Airbnb and Uber and where freelancing is a growing trend, it’s no surprise that unconventional loans are re-emerging to cater to those without standard income documentation.