America’s financial institutions, like most businesses, know how to fill a need when they see one. Borrowers who are self-employed, have bad credit or are somehow shut out from obtaining a mortgage from a bank can instead go to non-bank lenders and have an easier time being approved for a home loan, including a non-qualified mortgage loan.
One problem, however, is that as non-bank lenders are starting to dominate the mortgage market, many of them don’t offer the same services to borrowers that ordinary banks or credit unions typically do. These include home equity loans and home equity lines of credit, or HELOCs, which are used by homeowners to pull equity out of their homes and use the money for home renovations, college bills and other expenses.
Instead of home equity loans and HELOCs, many non-bank lenders offer cash-out refinances, which can also be used to pay for home renovations and other expenses such as consolidating debt.
What is a non-bank lender?
Many lenders collapsed after the 2008 financial crisis. Some were mortgage lenders that increased the housing bubble by issuing loans to high-risk borrowers. The home loans weren’t funded by tapping deposits, as traditional banks do, but by lenders borrowing against lines of credit and then selling the mortgages to investors.
Non-bank lenders have made a comeback since then, becoming the largest source of mortgage lending. Non-banks service about 51% of all loans packaged into new Freddie Mac securities, according to a 2018 review by mortgage analytics firm Recursion Co. Non-bank lenders held 9% of all mortgages issued in 2009.
You may have seen advertisements from non-bank lenders, which tend to exclusively issue mortgage loans or mortgage refinancing. They usually don’t offer deposit accounts.
Six of the 10 largest mortgage lenders in the United States are non-banks. Non-bank lenders include Quicken Loans, LoanDepot, New American Funding, Prime Lending, Mr. Cooper and Nationstar Mortgage. LoanDepot and Mr. Cooper are two of the few exceptions that offer home equity loans.
Mr. Cooper, which is part of Nationstar Mortgage, offers home equity loans, which it calls closed-end second lien home equity loans. These are fulfilled and originated through a third party lender, says Kurt Johnson, chief credit officer at Mr. Cooper in Dallas. It also offers cash-out refinances, which other non-bank lenders also do.
Why are they growing?
They’re gaining market share partly because traditional banks are getting out of or scaling back their mortgage offerings after new consumer protections enacted after the 2008 financial crisis made underwriting standards tougher. Lenders were required to do more paperwork when vetting borrowers, which increased their costs, and their liability increased. The bank Capital One got out of residential mortgages entirely.
Non-bank lenders saw an economic opening, filling the gap by offering home loans to people with less than perfect credit. Non-bank lenders don’t have the same oversight rules that traditional banks have. Also to their benefit is that they’re privately owned.
They also have mortgage guarantees from federal agencies such as the Federal Housing Administration and the Department of Veterans Affairs that will pay back investors if borrowers default.
FHA loans offer low down payments and help meet the FHA’s congressional mandate to make mortgage credit accessible to the middle class. Non-bank lenders originated about 85% of FHA mortgages in 2016, up from 57% in 2010, according to the FHA. Many of those loans are to black and Latino borrowers, who are more likely to need a loan that requires a smaller down payment, according to a Brookings Institution paper about the rise of non-bank lenders.
Downsides of equity loans to non-bank lenders
Lower-income and minority borrowers disproportionately rely on non-bank lenders, partly because they can’t get a mortgage at traditional banks. They’re also less likely to get a home equity loan or HELOC from non-bank lenders, most of which don’t offer them for a few reasons.
The biggest is probably money, or the lack of it. They don’t make much of a profit from home equity loans, says Michael Drake, president of PMG Home Loans in Granite Bay, Calif.
“Most non-bank lenders earn their costs and gain profit from the fees associated with the loan,” Drake says, “most of which are based or priced based on the loan amount. HELOCs are generally much smaller loan amounts yet cost the same to originate, process and close as a traditional first mortgage. This greatly impacts a non-bank lender’s ability to operate at a price point that makes sense.”
Also, HELOC interest rates are typically adjustable and change as the prime rate changes. A changing rate can be challenging for a non-bank lender to maintain, along with all of the servicing changes and any “draws” the consumer might make on the credit line, he says.
“A HELOC is a viable loan for homeowners,” Drake says, “just not always a good choice for a non-bank lender to offer direct to the consumer.”
Another drawback of home equity lines is that there isn’t a secondary market where non-bank lenders can sell the loans after they close, says Ben Anderson, branch manager at PRMG in Irvine, Calif.
Why go with a non-bank lender
Traditional banks can offer lower rates on home equity loans as a way to entice customers in the door. But if they don’t qualify for a home loan in the first place with a good credit score, they may find it easier to get a first mortgage at non-bank lenders.
For people who have experienced a major credit event in the last few years — such as a bankruptcy, foreclosure or short sale — non-bank lenders can be easier to get a home loan from.
One downside is that when you’ve built up enough equity in your home and want to pull some of it out, it can be hard to find a non-bank lender who will give you a home equity loan or line of credit. Cash-out refinancing is usually possible, but it can only make financial sense if the rate is lower than what you already have on your mortgage, and you plan on staying in the home for a few years to make up for the fees paid to get the loan refinanced.
In fact, refinancing is a large part of the business of some non-bank lenders, according to the Brookings report. That would likely drop if interest rates rise. Until then, that leaves cash-out refis as the main option for non-bank home loan borrowers looking to pull some extra money out of their home.