What Is Alt-A?
Alt-A is a classification of mortgages with a risk profile falling between prime and subprime. They can be considered high risk due to provision factors customized by the lender. This type of loan tends to be more expensive for the borrower, as they may carry higher interest rates and/or fees.
- The risk of an Alt-A borrower typically falls between prime and subprime.
- Alt-A loans were popular during the 2007–2008 financial crisis and have seen improvements since then, thanks to Dodd-Frank regulations and an improved economy.
- Alt-A loans typically have higher loan-to-value (LTV) and debt-to-income (DTI) ratios and lower down payments than prime loans, carrying higher risk and thus higher interest rates.
Alt-A loans are generally considered in a lender’s risk management diversification. These loans historically have been known for high levels of default, and their widespread defaults were a key factor leading to the 2007–2008 financial crisis.
Characteristics of Alt-A Mortgage
Several things distinguish Alt-A mortgages from other types of mortgage loans. For example, conforming loans refer to mortgage loans that conform to commonly accepted mortgage standards. Government-backed loans are insured by the full faith and credit of the federal government. Conventional loans can be conforming or nonconforming. Meanwhile, U.S. Department of Agriculture (USDA) loans, Federal Housing Administration (FHA) loans, and U.S. Department of Veterans Affairs (VA) loans are all types of government-backed loans.
An Alt-A mortgage loan represents an alternative to these types of loans. As such, they share some unique characteristics:
- Borrowers may qualify with lower incomes, or there may be fewer documentation requirements
- Loans may approved for borrowers with higher debt-to-income (DTI) ratios
- Subprime credit scores are generally not a barrier to getting an Alt-A mortgage, though there may be restrictions on borrowers with recent bankruptcies, charge-offs, judgments, or foreclosures
- Higher loan-to-value (LTV) ratios may be accepted
In other words, Alt-A loans are easier for borrowers to get. But that doesn’t necessarily make them an ideal mortgage option if the homebuyer is unable to afford payments over the long term.
Alt-A loans fall between prime and subprime credit quality, having seen improvements in both origination quality and quantity since the 2007–2008 financial crisis.
Advantages and Disadvantages of Alt-A
While Alt-A loans have become less prevalent in the mortgage market, there are still a class of borrowers to whom lenders choose to give these loans because they’re willing to take on the risk. In addition to the lower documentation standards that were addressed from new regulations, these loans also had other alternative characteristics.
These characteristics include higher LTV ratios, low(er) down payments, and higher accepted DTI ratios. DTI ratios are usually higher than the standard 36% and may even exceed 43%.
The alternative characteristics can help some borrowers with higher credit scores but lower income to obtain mortgages for a home purchase. These loans also benefit lenders since they charge higher rates of interest and can help to increase earnings. Overall, Alt-A loans continue to be higher risk than prime mortgages and are vulnerable to spikes in defaults when an economic downturn hits.
Alt-A vs. Prime vs. Subprime
Alt-A mortgages are in a separate class from prime and subprime mortgages. Prime, subprime, and Alt-A refer more to the class of borrowers to whom these loans are offered than to the loans themselves. Prime mortgage loans, for example, are typically reserved for borrowers with the highest credit scores and lowest DTI ratios. These borrowers are the most creditworthy in the eyes of lenders and have the strongest ability to repay a mortgage loan.
Subprime borrowers tend to have much lower credit scores, lower incomes, and higher DTI ratios. These borrowers represent the highest risk to borrowers because their past credit history typically suggests that they’ve struggled with debt repayment and money management before. Alt-A borrowers are somewhere between prime and subprime in terms of their qualifications.
They may not have the best credit scores, but they don’t necessarily have the worst. And they may have higher incomes but higher DTI ratios. An Alt-A borrower doesn’t fit neatly into either the prime or subprime box, because they otherwise may be able to qualify for a conforming mortgage loan but have one or two factors holding them back.
Alt-A Mortgage Scrutiny
One of the higher risks associated with Alt-A loans is less loan documentation. These types of loans were especially prominent leading up to the 2007–2008 financial crisis. Lenders of Alt-A loans issued these loans without significant documentation of income or verification of employment from the borrower. Alt-A loans were a substantial factor leading to the subprime crisis, which reached its peak in 2008, with many borrowers defaulting on their mortgage loans. Dodd-Frank regulations, implemented as a reaction to the fallout from the crisis, has helped improved documentation and verification weaknesses prevalent prior to these new rules.
Dodd-Frank regulations require greater documentation on all types of loans (specifically mortgages). The legislation has instituted provisions for qualified mortgages, which are high-quality mortgages that meet specific standards and thus qualify for special treatment in both the primary and secondary markets.
Who qualifies for an Alt-A mortgage?
Borrowers with lower credit scores or higher debt-to-income (DTI) ratios may be able to qualify for an Alt-A mortgage loan. There may be fewer documentation requirements for this type of loan, and higher loan-to-value (LTV) ratios also may be accepted.
Are Alt-A Loans subprime?
Alt-A loans are somewhere between prime loans and subprime loans in terms of what’s needed to qualify, the type of borrowers for whom they’re designed, and the risks involved for the lender.
What is an example of an Alt-A loan?
An Alt-A loan may be one that requires little or no documentation to obtain, such as a stated income loan. Loans that allow for 100% financing of the property also can be categorized as Alt-A. When comparing Alt-A loans, it’s important for borrowers to understand the cost in terms of the interest rates and fees.