Alt-A Loans

The term "Alt-A" is a generic term for any loan that isn*t prime (A-paper) or sub-prime.  Often as not, these refer to any mortgage other than a fixed rate, level payment mortgage.  An Alt-A loan is not really a loan type.  Alt-A is a way lenders have of grading a loan and its method of documentation.  Perhaps the easiest way to distinguish what is Alt-A is by comparison:  "A-paper" refers to high quality loans made to borrowers with excellent credit scores who fully document their income and assets while alternate-A loans are high quality loans made to borrowers with good credit scores but who can't or, for whatever reason won't fully document their finances.  These two designations have morphed together somewhat.  Alt-A is synonymous with A-minus and has been used to signify borrowers whose credit scores are slightly below those of A borrowers, typically under 680.  Yet, there are Alt-A borrowers with credit scores ranging from 620 to as high as 800+.  The Alt-A designation is more frequently applied to loans that have less than full documentation or "alternative" documentation.

While Alt-A loans are primarily credit-score driven (from 620 to 800+), borrowers are most often in this category because they don*t conform to standard Fannie Mae and Freddie Mac guidelines with respect to property type, debt ratio or loan-to-value ratio. The Alt-A loan avoids these issues but, borrowers do pay a slightly higher interest rate, usually from a quarter- to half-point higher than traditional, fully documented loans.  Alt-A loans (or non-primes) command better pricing than the sub-primes (credit scores of less than 620).  

CREDIT SCORE

While Alt-A borrowers may have some credit dings, there is nothing too grievous.  Of course, were they to have a bankruptcy filing or other major derogatory, this would demote them to sub-prime status.  Despite an excellent credit score, one reason for being deemed Alt-A might be that the borrower has a limited credit history, either one that is too new or with too few trade lines to qualify for an A paper loan.  Remember, credit score means very little without solid history behind it.

LIMITED DOCUMENTATION

One of the most salient characteristics of Alt-A mortgages is their tendency to be limited documentation loans.  Most so-called Alt-A loans are not full doc, meaning income is not verified, but rather stated or not disclosed.  These loan programs were created to provide credit for self-employed individuals who lacked the typical documentation records such as payroll stubs and W-2 forms.  Others may have been recent divorcees, entrepreneurs or business partners who earned income but were still unable to meet a lenders* established documentation requirements.  Or, they may have been retirees with substantial assets.  As with employment documentation, the same goes for asset documentation. If a borrower prefers not to verify asset reserves or disclose employment history, the loan may also be referred to as an Alt-A loan. These factors alone can often categorize a loan as Alt-A, even if the associated credit score is excellent and down payment is ample.

Stated income loans with verifiable assets evolved into stated income stated asset loans which begat No Ratio and No Income No Asset loans and ultimately, No Doc loans.  (See the May 2006 newsletter Vol. 3 Issue 5 for a detailed discussion of these loans). Note: the No Ratio, No Income No Assets (NINAs) and No Doc loans have disappeared from the lending landscape because investors are unwilling to buy them.

HIGH LOAN-TO-VALUE

Another characteristic of Alt-As is their high LTV.  Most mortgages that fall into this category are characterized by minimal down payments, if any at all.  The most common of these were the piggybacks with an 80% 1st and a 20% 2nd.  These are also the ones that borrowers who now owe more than their house is worth are most often walking away from because they had little other than their credit score invested in the property.  Today, an Alt-A loan is typically in excess of 80% and more often than not, above 90% LTV.  For a second home or an investment property, financing in excess of 80% Loan to Value (especially now) classifies the loan as Alt-A. Such a loan is a riskier proposition for a lender because with *little or no skin in the game* a borrower is more apt to seek a short sale or simply walk away from the property and let it go into foreclosure if he (or she) is delinquent on their payments.

 DEBT-TO-INCOME RATIO

Typically, debt-to-income ratios (DTIs or DIRs) are higher with an  Alt-A loan, as well.  Instead of a DTI ratio of 28% for housing expense and 36% for combined housing and consumer debt, the DIRs may be more in the neighborhood of 35/45, respectively. This allows the borrower to buy more *house* or put less down which could ultimately stretch a borrower too thin, leading to a higher frequency of payment default and one more reason that Alt-A loans are priced slightly higher.

Because of their more expansive limits, Alt-As necessarily have higher interest rates.  It's basic economics:  the higher the risk, the higher the reward or yield (required by the lender).  Naturally, the combination of a high LTV, a high DTI, a low FICO and limited documentation is apt to require a commensurately higher interest rate.

One or all of the above elements may cause the loan or the borrower to be designated Alt-A.

Copyright 2020 Rod Haase.  All rights reserved.