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The mortgage market is facing a crisis today, and it’s being fueled by fast-rising interest rates. 

The rate escalation started at the beginning of this year and is continuing to play out. It’s a crisis that one industry executive describes as “a situation where we have to get the pig through the belly of the python.”

The mortgage industry, really the entire economy, is coping with fast-rising inflation further aggravated by jammed-up supply chains, the escalating war in Ukraine, and the related, expanding sanctions that are whipsawing the global economy. That economic environment has led to spiking interest rates driven by a hawkish Federal Reserve policy and free-market forces — with rates up more than 1.5 percentage points since the beginning of the year and still rising.

For the sector of the mortgage market engaged in non-QM lending, the volatile rate environment is a particular challenge. Non-QM lenders are dealing primarily with purchase loans that require far more intensive underwriting than agency loans and, once funded, must be moved off the balance sheet quickly in most cases to maintain liquidity. That is typically accomplished through whole loan sales or private label securitizations along with hedging — such as the use of third-party forward contracts that allow for bulk loan sales at a future date at a predetermined rate. 

Non-QM mortgages include loans that cannot command a government, or “agency,” stamp through Fannie Mae or Freddie Mac. The lenders originating in the non-QM space make use of alternative-income documentation because borrowers cannot rely on conventional payroll records or otherwise fall outside agency credit guidelines. The pool of non-QM borrowers includes real estate investors, property flippers, foreign nationals, business owners, gig workers and the self-employed, as well as a smaller group of homebuyers facing credit challenges, such as past bankruptcies. 

Some non-QM lenders have parent companies in the private equity space or have affiliates organized as real estate investment trust, and some even have affiliated real estate mortgage investment conduits (REMICs). Those entities can help to buy or warehouse loans for their non-QM lending affiliates for a time to deal with a liquidity challenge. But regardless, they all face the same problem: coping with rates rising at a faster clip than the market has seen in decades.

“You got to pay the piper if you’re stuck with bad loans,” said Keith Lind, CEO of non-QM lender Acra Lending. “You have to sell at some point.”

What this rate crisis means for lenders in the non-QM space is that the loans they made at the start of the year at a lower coupon were worth less in the whole-loan or private label securitization market than the loans they funded a month or even a week later at a higher coupon rate.

“We haven’t seen rates move like this in 40 years,” Lind said. “The problem in the market right now is there’s all these distressed loan portfolios out there [composed of lower-rate loans].” 

Thomas Yoon, president and CEO of Excelerate Capital, another non-QM lender, offered this anecdote to illustrate what his company and his fellow non-QM lenders are facing:

“On January 3 of this year, we put out a bulk loan offering of $150 million, and we found that that it was worth more than 50% less than what it was just a week or two earlier. …It was slightly above par [in early January] and just a few weeks earlier, I’m talking in the fourth quarter, we could have probably executed north of 103 [above par]. So, overnight, the bottom dropped out on us.”

Non-QM executives who agreed to answer questions from HousingWire about the current rate crisis stressed that the future remains uncertain. However, finally, well into April now, higher-rate loans are starting to find their way into the pipeline, some executives said, which should help lenders execute on loan trades and securitizations at better margins going forward.