Banks vs Nonbanks

Harvard’s School of Government released a study this month analyzing the recent shift in borrowing from banks to nonbank lenders in the U. S. mortgage market. It focused on the reemergence of non-depository lenders, also known as nonbank lenders, and the role they are playing in the current residential mortgage market.

Nonbank lenders have seen residential mortgage market share surge from 27 percent in mid-2012 to 48 percent in late 2014, and because of this unprecedented growth, politicians and policymakers have showed concern. This prompted Fannie Mae and Freddie Mac to change their operational and financial eligibility requirements for single family/seller services. These go into effect Dec. 31, 2015.

The conductors of the study examined the risk profile of nonbank lenders and found that FHA-insured loans are a factor, which is logical since the purpose of FHA is to provide alternatives for buyers who might not otherwise qualify for traditional loans with 20-percent down and excellent credit. The median FICO score of an FHA-insured nonbank borrower is 667, compared to 682 for banks. However, at some nonbank lenders it can be below 660. The Cleveland Federal Reserve classifies this as subprime and finds that 26 percent of recent FHA-insured loan originations went to borrowers with scores beneath this threshold.

This could be a concern if some nonbank lenders pushed this minimum threshold, but that is why the new standards referenced above will be so strict. With protections in place, the nonbank-lender segment is likely to continue growing.

The factors that have contributed to the nonbank-lender boom include:

ü  Mortgage regulation that has been tightened. Federal oversight now encompasses both banks and nonbank-lenders, with additional tightening at the state level. This was not the case during the pre-crisis years.

ü  Technological innovation by nonbank lenders is improving customer service, which helps drive up the market share.

ü  Banks (depository institutions) have become extremely selective to whom they lend to; taking only the most premium customers, as they contend with more stringent regulations, fines, and legal actions, which compel them to take minimal risk.

ü  Nonbank lenders have a much larger FHA-insured portfolio, which includes the higher-risk borrowers.

The study concludes that nonbank lenders are emerging to meet a market need. It examined Consumer Financial Protection Bureau complaint data and found that the segment is improving the customer experience. They also take into account nonbank originator and servicer innovations and recommend that regulators consider how nonbank lenders have changed.

If regulators continue to monitor concerns about risk, stability, consumer protection and market fairness, customers are in a position to greatly benefit from nonbank-lender offerings.

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