Mortgage lenders offer proof to the adage, “Rules are meant to be broken.”  Government regulations that took effect Jan. 10 set new qualification standards for all mortgages, including conventional government-backed loans and jumbo loans—those that exceed $417,000 in most areas and $625,500 in some high-price areas. At first, lenders backed away from loans that didn’t meet the new rules, but that’s beginning to change.  New Penn Financial, for example, introduced in September its first nonqualified jumbo mortgage product. It allows a debt-to-income ratio (DTI) up to 55%. The DTI looks at monthly debts as a percentage of gross monthly income.  Under federal rules, borrowers can’t have a debt-to-income ratio above 43%. New Penn also has an interest-only option, in which the borrower’s initial payments cover only the monthly interest and not the loan’s principal.  “We see an under-served market of people who have excellent credit and strong income but have had a lot of debt,” says Brian Simon, COO of the Plymouth Meeting, Pa.-based lender. Examples include recent law- or medical-school graduates, he adds.  The lender is also developing another potential nonqualified product targeting self-employed borrowers, whose regular earnings can be difficult to document. Instead, the lender reviews the borrower’s bank statements, which can better reflect liquid assets.  Still, lenders who bend the rules put themselves at risk, since only those that offer qualified mortgages are protected from lawsuits filed by borrowers who default on the loans.  Guardhill Financial, a New York-based lender, is also issuing both interest-only jumbo mortgages and loans to some borrowers who exceed the 43% DTI limit. Interest-only loans are especially attractive to borrowers who receive substantial year-end bonuses, says Alan Rosenbaum, the company’s CEO.  Of course, the purpose of the federal rules was to prevent consumers from taking on more debt than they could afford to repay. But many lenders felt that the restrictions were constraining their ability to work with wealthy borrowers who “do not formally meet ability-to-pay requirements but still have excellent credit attributes,” says Cameron Findlay, chief economist for Discover Home Loans, which is considering offering a nonqualified jumbo mortgage product.  So far, most of the nonqualified jumbo loans are made by small and medium-size banks.  The problem typically stems from income-documentation challenges, he explains. In a much-publicized recent example, former Federal Reserve Chairman Ben Bernanke was turned down when he tried to refinance his three-bedroom home in Washington, D.C.  Lenders have more flexibility when issuing jumbo mortgages, since many are keeping the loans on their books instead of selling them as mortgage-backed securities, where investors tend to be risk-averse. Only 2% of all jumbo mortgages have been securitized in 2014, according to Inside Mortgage Finance, an industry publication.  Guy Cecala, CEO and publisher of Inside Mortgage Finance, predicts an uptick in nonqualified jumbo lending. In 2014, an estimated 15% of all jumbo mortgages will be nonqualified, he says. Next year, nonqualified jumbos could make up a quarter of the market. “There’s a lot of talk about people getting into that market and not a lot of loans being originated, but that’s going to change in the latter part of the year and into 2015,” Mr. Cecala says.  Here are a few more considerations for borrowers looking into a nonqualified jumbo:  • Higher costs. On loans to borrowers with higher debt-to-income ratios, expect the lender to require a better credit score, charge a higher interest rate and require a 30% down payment, Mr. Cecala says. “A larger down payment rebuffs any argument down the road that you can’t repay the loan,” he adds. New Penn Financial’s nonqualified mortgage requires a credit score of 720 or higher, a 20% down payment, and has an interest rate between 5/8 to 125 basis points higher than its qualified mortgage jumbo.  • Reserves still important. Lenders typically want to see six months of liquid assets to qualify a jumbo borrower, Discover Loans’ Mr. Findlay says.  • Geography may matter. Lenders may be more likely to offer nonqualified mortgage lending in states where the foreclosure process is faster, such as California, Mr. Findlay says. In the event a borrower defaulted on the loan, the bank could start proceedings early on and minimize its losses.  • Rules may change. Federal mortgage rules are under review, so qualification standards may still loosen. Lending giants Fannie Mae and Freddie Mac this week announced that they are working on guidelines that would reduce the minimum down payment percentage from 5% to 3%, in an effort to fuel the housing recovery.
Some lenders bypass tightened mortgage rules when dealing with wealthy clients who, on paper, don’t meet government standards.