mortgage, short for Alternative A-paper
, is a type of U.S. mortgage
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
that, for various reasons, is considered riskier than A-paper
A-paper is a term to describe a mortgage loan for which the asset and borrower meet the following criteria:* In the United States, the borrower has a credit score of 680 or higher* The borrower fully documents his income and assets...
, or "prime", and less risky than "subprime
In finance, subprime lending means making loans to people who may have difficulty maintaining the repayment schedule...
," the riskiest category. Alt-A interest rates, which are determined by credit risk
Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised. Such an event is called a default. Other terms for credit risk are default risk and counterparty risk....
, therefore tend to be between those of prime and subprime home loans. Typically Alt-A mortgages are characterized by borrowers with less than full documentation, lower credit scores, higher loan-to-values, and more investment properties. A-minus is related to Alt-A, with some lenders categorizing them the same, but A-minus is traditionally defined as mortgage borrowers with a FICO
Fico may refer to:* Fair Isaac Corporation , an American company* FICO score, a credit score developed by Fair Isaac Corporation * Hurricane Fico, a hurricane in the 1978 Pacific hurricane season...
score of below 680 while Alt-A is traditionally defined as loans lacking full documentation. Alt-A mortgages may have excellent credit but may not meet underwriting criteria for other reasons.
Alt-A loans should be not be confused with alternative documentation loans, which are typically considered to have the same risk as full documentation loans despite the use of different documents to verify the relevant information.
Characteristics of Alt-A
Within the U.S. mortgage industry, different mortgage products are generally defined by how they differ from the types of "conforming" or "agency" mortgages, ones guaranteed by the Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac.
There are numerous factors that might cause a mortgage not to qualify under the GSEs' traditional lending guidelines even though the borrower's creditworthiness is generally strong. A few of the more important factors are:
- Reduced borrower income and asset documentation (for example, "stated income", "stated assets", "no income verification")
- Borrower debt-to-income ratio
A debt-to-income ratio is the percentage of a consumer's monthly gross income that goes toward paying debts. A debt-to-income ratio (often abbreviated DTI) is the percentage of a consumer's monthly gross income that goes toward paying debts. A debt-to-income ratio (often abbreviated DTI) is the...
s above what Fannie or Freddie will allow for the borrower credit, assets and type of property being financed
- Credit history with too many problems to qualify for an "agency" loan, but not so many as to require a subprime loan (for example, low FICO score or serious delinquencies, but no recent charge-offs or bankruptcy)
- Loan to value
The loan-to-value ratio expresses the amount of a first mortgage lien as a percentage of the total appraised value of real property. For instance, if a borrower borrows $130,000 to purchase a house worth $150,000, the LTV ratio is $130,000/$150,000 or 87%.Loan to value is one of the key risk...
ratios (percentage of the property price being borrowed) above agency limits for the property, occupancy or borrower characteristics involved
In this way, Alt-A loans are "alternatives" to the standard of conforming, GSE-backed mortgages.
An example of a person requesting a Stated Income mortgage is an individual with multiple and varying sources of income that would require an onerous amount of paperwork to document, such as income from self-employment or investments. Note that reduced documentation loans still require that borrowers authorize the lender to order their tax returns at random from the Internal Revenue Service in order to verify the income on the application.
The same documentation features are available under "subprime" guidelines, and similar ones may even be available under agency guidelines. Alt-A and subprime differ in that, generally speaking, an Alt-A borrower would have had a sufficient financial profile to qualify for a "conforming" mortgage, if only it weren't for one of the factors mentioned above, whereas a subprime borrower would suffer from exceptionally weak credit, income or asset characteristics. However, in cases where borrower, property and loan characteristics meet agency guidelines especially well, Fannie's and Freddie's automated preapproval systems generally grant reduced documentation features automatically at no extra cost. More expensive Alt-A or subprime loans are not necessary for strong borrowers to expedite their applications.
Aside from reduced documentation features, Alt-A guidelines usually also offer borrowers greater flexibility than agency guidelines concerning borrower credit scores, income and asset levels. Thus a borrower whose financial profile might not meet agency guidelines for the loan terms requested might still be eligible under Alt-A guidelines.
Property and occupancy considerations
Aside from the borrower's credit and financial profile, GSE standards are also generally the most stringent regarding how much of a given property type's value or purchase price is permissible to lend on owner-occupied, second ("vacation") and non-owner occupied ("investment") homes, and under what conditions. The combination of these property and occupancy factors with a given borrower's profile can move the loan out of the "prime" category of agency-conforming loans and into less stringent categories such as Alt-A and subprime. For example, Fannie Mae might agree to purchase all loans made by a particular lender on single family second homes in a particular area at a particular maximum LTV for borrowers within given income, asset and credit limits. Borrowers beyond those limits, or those seeking loans above that maximum LTV for second homes, would need to apply for an Alt-A loan. Borrowers still further outside the income, asset and credit limits might need to consider subprime financing -- difficult to find as of 2008.
Similar to Alt-A lending, the jumbo and super-jumbo
A Super Jumbo Mortgage is classified in the United States as a residential mortgage or other home-equity secured loan in an amount greater than $650,000, although lenders differ on just what constitutes a super jumbo mortgage subject to their own internal investment criteria...
categories generally use an amalgam of agency and Alt-A guidelines for borrower eligibility while allowing larger maximum loan amounts than those permitted by the GSEs (as of 2007, $417,000 for a single family home outside Alaska, Hawaii, Guam and the US Virgin Islands).
Revaluation of risk
During the subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
that began in 2007, Alt-A mortgages came under particular scrutiny.
One problem associated with Alt-A loans is the lack of necessary proof or documentation needed to be approved for a loan. Thus, lenders may be inclined to suggest borrowers skew their incomes or assets in order to qualify for a larger loan; in the long run, the borrowers may turn out to be unable to afford their payments but the lenders still collect a hefty profit. Because Alt-A loans are also the financing of choice for most non-owner occupied, investment properties, as a class they represent a far greater likelihood of borrower default than conventional, conforming mortgages, since people are more likely to abandon a property in which they do not live than they are to risk losing their primary homes. As of 2008, there was strong evidence of weakness among securities backed by Alt-A mortgages for reasons similar to the crisis in those backed by subprime.
Because Alt-A loans were not primarily purchased by the GSEs, they thus became more expensive and much harder to find as a result of the general crisis in markets for mortgage-backed securities. Alt-A loans were still available from individual institutions which held them "in portfolio" rather than re-selling them to investors, and as of mid-2008 there was a strong push for the FNMA and FHLMC to be permitted to buy more of them. However, the interest rates in this lending category increased substantially between 2006 and 2008 as a result of the shrinking secondary market
The secondary mortgage market is the market for the sale of securities or bonds collateralized by the value of mortgage loans. The mortgage lender, commercial banks, or specialized firm will group together many loans and sell grouped loans as securities called collateralized mortgage obligations ....