Before the 2007 – 2008 financial crisis, lenders and financial institutions were handing out money left and right. It almost seemed that anyone who wanted a mortgage, all they needed to do is simply ask. There are many factors in the financial crisis, and Alt-A mortgages alongside its subprime sibling are part of those factors.
In this article, you will learn ‘what are Alt-A mortgages.’ This article is part of a series ‘All About Mortgages’ that answers questions pertaining to those who seek out a general knowledge on the subject matter.
What is an Alt-a Mortgage?
In short, Alt-A (Alternative A-paper) refers to a risk categorization that is considered riskier than “prime” or A-paper. This risk categorization usually involves the income and assets of the borrower that is not fully documented, has higher loan-to-values, average credit scores, contains investment properties, etc. This categorization generally disappeared in 2007 – 2008 during the financial crisis.
In addition, an Alt-A mortgage lies between a prime and sub-prime mortgage categorization. For instance; a prime loan is offered to a borrower who has a higher credit rating resulting in lower interest rates. A sub-prime loan is offered to a borrower with a lower credit rating resulting in higher interest rates. Everything else that falls in between them is the Alt-A loans.
Generally, applicants who qualified for these types of mortgage loans typically had a creditworthy history, however, generally had other issues that did not meet the standard requirements. These issues increased the applicant’s risk profile. Issues may involve unemployment, divorce, medical emergencies, higher loan-to-value, high debt-to-income ratio, and even inadequate documentation.
The Alt-A Mortgage Problem and The Financial Crisis
During the 2007 – 2008 financial crisis the housing market witnessed a correction. This spun off quickly that correlated with the mortgage lending industry, specifically on how the subprime and Alt-A market conceived its underwriting standards.[1] In other words, these loans that were issued by lenders were very low in the quality of documentation. Loans were granted without any verification of employment and income. These loans started out that once accounted for 1 to 3 percent of the market but ended up to as high as 20 percent of the market before the financial crisis.[2]As a result the Dodd-Frank legislation was enacted in July of 2010. The Dodd-Frank Act puts regulations on the financial industry to limit mortgage companies and lenders from taking advantage of consumers. A key provision is the Consumer Financial Protection Bureau (CFPB), which is an independent financial regulator that oversees these mortgages, enforcing regulatory requirements that increase the underwriting standards for consumers, e.g. verifying employment and income.
Alt-A and Limited Documentation
Under full documentation, the applicant met the standard approach. That is, both the applicant’s assets and income are fully disclosed and verified. The applicant’s employer verified employment and the applicant’s bank verified deposits. With the Alt-A classification, borrowers were limited in their ability to disclose documentation. This is where alternative documentation became acceptable.
Verified Assets
Verified assets are where the applicant’s income is disclosed and the source of that income is verified, however, the amount is not verified.
Stated Assets
States assets are where the applicant’s income and assets are both disclosed and the source is it is verified, but the actual income and assets itself is not verified.
No Ratio
With no ratio, the applicant’s income and assets are disclosed and verified but not used to qualify the applicant. The standard rule, in that, an applicant’s expenses must meet a percentage of income, is ignored.
No Income
With no income, the applicant’s income is not disclosed, but the applicant’s assets are disclosed and verified.
No Asset Verification
Under the no asset verification, the applicant’s asset is disclosed but not verified and the applicant’s income is disclosed and verified.
No Asset
Under no asset, the applicant’s assets are not disclosed, but the applicant’s income is disclosed and verified.
No Income-No Asset
Neither the applicant’s income or assets are disclosed.
Benefits of Alt-A Mortgages
What is an Alt-A mortgage good for? An alternative mortgage can be a good option for borrowers who cannot document all their assets or those who do not have a constant stream of income. Small business owners could greatly benefit from Alt-A mortgages due to their trouble documenting their source of funds for down payments and proof of ability to pay back. “The bank is not particularly interested in the success or failure of your business. The bank’s concern is whether the money it is lending is safe and will be repaid.”[3] Moreover, before the financial crisis of 2008, lenders were able to give these types of loans and develop a favorable bias towards issuing loans. Many lender salaries are based on commission, therefore, as long as they are meeting the guidelines of the type of mortgage then the loan may be processed.
The Overview of What is an Alt-A Mortgage?
Low Credit Rating
Borrowers with a credit rating low (less than 620) or the borrower have a limited credit history.
Bad Credit
Borrowers applying for a mortgage within the waiting period or they have some serious credit problems with respect to personal complication like foreclosure, short sale or bankruptcy.
High Debt-to-Income Ratios
Mortgages with a debt to income ratios for borrowers between 50% and 55%. The higher the debt ratio is, the higher the chances for the borrower to qualify for the goof mortgage amount.
Limited Documentation
Declared income, less or no documentation allowing borrowers to obtain loans with little or no personal financial documents. These programs are often used by independent borrowers or borrowers whose main source of income is income from invested assets.
Assets
Collection of mortgages on investment properties or rental properties when the owner owns properties of more than 5. This will help you in properly evaluate your financial balance and having a proper loan too.
Conclusion
Alt-A mortgages may be rare and a thing of the past, since legislation and other factors increased the standard of the underwriting requirements for mortgages. However, Alt-A is still a classification of mortgages that is riskier than prime but not as riskier as subprime. It stands in the middle of these two classifications. These loans were once, along with its sibling subprime considered one of the factors that lead to the financial crisis of 2007 – 2008.
Biblography
[1] Abreu, Steven M. “The Alt-A Mortgage Problem? Too Many Rookies Making Loans.” American Banker 27 May 2004: 11. Business Insights: Global.
[2] Ibid
[3] Krass, P. (1999). The Book of Entrepreneurs Wisdom. John Wiley & Sons, Inc.
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