What is 'Alt-A'
Alt-A is a classification of mortgages with a risk profile falling between prime and subprime. These loans are usually issued to top credit quality borrowers with good credit histories. However, they usually have some high risks due to provision factors customized by the lender.
BREAKING DOWN 'Alt-A'
Alt-A loans are generally considered in a lender’s risk management diversification. Historically these loans have been known for high levels of default and their widespread defaults were a key factor leading to the 2008 financial crisis.
Alt-A Loans and the 2008 Financial Crisis
One of the higher risks associated with Alt-A loans is lower quality loan documentation. These types of loans were especially prominent leading up to the 2008 financial crisis. Lenders of Alt-A loans issued these loans without significant documentation of income and employment from the borrower. These Alt-A loans were a substantial factor leading to a subprime crisis and mortgage fallout that reached its peak in 2008 with many of these borrowers defaulting on their mortgage loans. New regulations from Dodd-Frank generally improved this area of weakness for the mortgage market.
Dodd-Frank regulations now require greater documentation on all types of loans and specifically mortgage loans. The legislation also instituted provisions for qualified mortgages which are high quality mortgages that meet specific standards and qualify for special treatment in the primary market and secondary market. Qualified loans have helped to improve the quality of loans issued in the mortgage market overall and these loans are also now more attractive to investment underwriters in structured loan product investments.
Alt-A Loan Structuring
While Alt-A loans have become less prevalent in the mortgage market they are still a loan classification issued by lenders. In addition to the lower documentation standards which were addressed from new regulations, these loans also had other alternative characteristics. These characteristics include higher loan-to-value ratios, low down payments and higher accepted debt-to-income ratios. Some Alt-A loans may have loan-to-value ratios of up to 100%. Debt-to-income ratios are usually higher than the standard 36% and may even exceed 43%. Also it can be common for Alt-A loans to require no down payment.
While fewer of these loans were issued immediately following the financial crisis they still continue to be a category of loans found on lenders’ balance sheets. 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 still continue to be a high risk category that can see volatile levels of defaults. (See also: Alt-A Mortgages: How They Work)