Magazine article Mortgage Banking

Two Different Market View Points: Lenders Should Not Rush Blindly into the Nonconforming Market. Here Are Some Things You Really Need to Know Beforehand about How Different Nonconforming Is from Conforming Lending

Magazine article Mortgage Banking

Two Different Market View Points: Lenders Should Not Rush Blindly into the Nonconforming Market. Here Are Some Things You Really Need to Know Beforehand about How Different Nonconforming Is from Conforming Lending

Article excerpt

FUELED BY HISTORICALLY LOW INTEREST RATES, THE recent refinancing boom has driven roughly three out of every four mortgage originations over the past few years. But refinancing is expected to slow in 2004, and most industry observers anticipate some increase in interest rates by the end of the year. This suggests the long-predicted end of the refinancing boom may be at hand.

Mortgage originators who geared up their operations to capitalize on the boom now face a dilemma. Given a saturated conforming market that is highly sensitive to interest rates, where can retail originators turn for the new business they need to support the organizations they have built?

The nonconforming alternative

Nonconforming markets offer a promising alternative. Nonconforming borrowers are usually less rate-sensitive than conforming borrowers for many reasons. And many hold high-interest balances on revolving debt. Rising interest rates create an incentive for these borrowers to trade equity for debt reduction or consolidation. While these nonconforming borrowers represent higher credit risk, they compensate originators with appropriately higher returns.

Nonconforming markets, however, are not for the fainthearted or the unprepared. Strategies that have produced record volumes in the black-and-white world of conforming A-paper markets won't necessarily work in the gray world of nonconforming originations.

From a credit perspective, nonconforming borrowers don't usually look or respond like conforming borrowers. Serving these prospects requires different marketing strategies and sales approaches, different orientations to processing and underwriting, improved technology capabilities, and--in most cases--a different investor base. Most importantly, the nonconforming market demands a new mindset on the part of the originating organization.

A new mentality

In the conforming world, originators essentially look for potential problems that would require a lender to turn down an application. If a loan review turns up no reason for denial, the loan proceeds. The process is so straightforward that originators now rely on automated underwriting systems to process most conforming applications.

In the nonconforming world, this mindset is reversed. By definition, the borrower fails to satisfy some key credit criterion, so the originator must look instead for some reason or reasons to proceed. This difference may sound simple, but its implications reverberate throughout the entire origination process.

The originator must drive the change in mentality through his or her entire origination process, from initial prospect selection and lead generation through back-office processing and placement with an investor. Like the origination process itself, this reorientation process must begin with marketing.

Retail marketing in the nonconforming environment

The refi boom made marketing simple. Originators simply notified homeowners that rates had reached a new low, and then prepared for the stampede of refinance phone calls. Originators competed principally on price and were content to let skyrocketing volumes compensate for thinner margins. Conforming borrowers literally jumped at the chance to trade upfront fees for substantial reductions in monthly payments or shorter terms.

Marketing to nonconforming borrowers is a far greater strategic challenge. Success requires far more understanding of the borrower's particular financial and credit condition, and far more understanding of the lifestyle events and incentives that can actually induce the borrower to close.

Originators must present their value proposition in more innovative and strategic ways, and must persevere through an extended sales cycle with more patience and responsiveness.

Historical loan performance

Originators who have survived and prospered in nonconforming markets are usually distinguished by their ability to identify certain critical attributes that make a retail deal acceptable. …

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