What Is Alt-A?
Alt-A loans fall between prime and subprime credit quality, having seen improvements in both origination quality and quantity since the Financial Crisis.
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.
- The risk of an Alt-A borrower typically falls between prime and subprime.
- Alt-A loans were popular during the Financial Crisis and have seen improvements since then thanks to Dodd-Frank regulation and an improved economy.
- Alt-A loans typically have higher loan-to-value, debt-to-income, and lower down-payments than prime loans, carrying higher risk, and thus higher interest rates.
Advantages and Disadvantage of Alt-A
While Alt-A loans have become less prevalent in the mortgage market, they are still a class of borrowers that lenders choose to give loans because they’re willing to take the risk on. 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(er) down payments and higher accepted debt-to-income ratios. Debt-to-income 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 and the Financial Crisis
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 2008 financial crisis. Lenders of Alt-A loans issued these loans without significant documentation of income and nor 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 market.