Some non-traditional borrowers, such as those who are self-employed, have bad credit or are otherwise limited from obtaining a home equity loan from a bank, may pursue financing from a non-bank lender.
That may be a viable option in some cases, but there are also some hurdles and conditions to consider before starting a dialog with a non-bank lender.
What is a Non-Bank Lender?
Many non-bank lenders contributed to the 2008 financial crisis, issuing loans to high-risk borrowers that weren’t funded by tapping deposits, as traditional banks do, but by lenders borrowing against lines of credit and then selling the mortgages to investors.
Since that collapse, non-bank lenders that include well known mortgage companies such as Quicken Loans, LoanDepot and others have made a comeback and now comprise about half of all loans packaged into new Freddie Mac securities.
You may have seen advertisements from non-bank lenders that tend to issue mortgage loans or refinancing exclusively. They usually don’t offer deposit accounts.
Home Equity Loans vs HELOCs
However, many don’t offer the same services to borrowers that ordinary banks or credit unions typically do. Many non-bank lenders don’t offer home equity loans or lines of credit (HELOC) that homeowners commonly use to pull equity out of their homes for major expenses.
A home equity loan allows you to borrow a specific amount of money based on how much equity you have in your home. It is repaid over time with fixed monthly payments. Each payment reduces the loan balance and covers interest costs on a familiar amortization schedule.
A HELOC gives you access to a line of credit that you may or may not use in any amount up to what you’re approved for. You can withdraw several times from the line of credit and make payments for many years before a fully amortized schedule kicks in.
Instead of home equity loans or HELOCs, non-bank lenders typically offer borrowers cash-out refinances as an alternative. Cash-out refinancing lets you turn equity into cash by refinancing your mortgage instead of taking a loan out in addition to your current mortgage.
You get access to a larger sum of money without needing to sell your home.
For example, with a cash-out refinance, let’s say you owe $250,000 on a $500,000 house. This means you have $250,000 of equity in your home. With a cash-out refinance, you could borrow $350,000, replace your mortgage with the cash-out refinance, and have $100,000 to use for other purposes.
A cash-out refinance is easier to qualify for because you already own the property and have the collateral to put up, which creates less risk for the lender. Also, you can get a cash-out refinance loan if you have a credit score of around 640, and in some cases, even lower.
Because you’re using your home as collateral, lenders are more forgiving if you have a lower credit score.
How Non-Bank Lenders View Home Equity and HELOC Loans
After the financial crisis, traditional bank lenders were required to do more paperwork when vetting borrowers, increasing their costs and liability.
Non-bank lenders saw an economic opening, filling the gap by offering home loans to people with less-than-perfect credit. However, non-bank lenders don’t have the same oversight rules traditional banks have; they’re also privately owned.
Lower-income and minority borrowers disproportionately rely on non-bank lenders, partly because they can’t get a mortgage at traditional banks. They’re also less likely to get a home equity loan or HELOC from non-bank lenders, most of which don’t offer them for a few reasons.
Rate of Return
The biggest issue is a lack of a reasonable rate of return. Non-bank lenders don’t make much of a profit from home equity loans.
Most non-bank lenders earn their costs and gain profit from the fees associated with the loan. These fees are usually based or priced based on the loan amount.
HELOCs are generally much smaller loan amounts yet cost the same to originate, process, and close as a traditional first mortgage. This dramatically impacts a non-bank lender’s ability to operate at a reasonable price point.
Interest Rates and Liquidity
Also, HELOC interest rates are typically adjustable and change as the prime rate changes. A changing rate can be challenging for a non-bank lender to maintain, along with all of the servicing changes and any “draws” the consumer might make on the credit line.
That means a HELOC is a good alternative loan for homeowners but not always a good choice for a non-bank lender to offer directly to the consumer.
Another drawback of home equity lines is that there isn’t always a secondary market where non-bank lenders can sell the loans after they close. That non-liquidity can create cash flow issues for non-bank lenders that they would rather avoid.