What is an Alt A Loan?

Alt-A loans did not exist 20 years ago and, after the Great Recession, may or may not exist in the future. However, although most of the subprime loans have disappeared, there may be a place for Alt-A financing. These loans are differentiated from pure "A" financing by the good, but not necessarily excellent, credit rating of the borrower and the acceptance of "alternate" documentation of income and other factors considered in loan approval--thus the combined term "Alt-A." The rates and terms of Alt-A loans can be more reasonable for the buyer than the terms of either a traditional loan or a subprime loan.

Function

Alt-A mortgage loans are differentiated from traditional loans by the documentation that is offered and accepted for approval. Typical conforming loan rules require specific forms of income and debt verification. Some borrowers have difficulty satisfying the usual requirements. Self-employed persons, commission only sales personnel, and independent contractors consistently face this problem. Alt-A loans were created to allow these borrowers to qualify for mortgage loans at good rates and terms.

Features

Instead of submitting W-2 forms (issued to salaried or hourly employees) for the prior two years, Alt-A borrowers can offer other documentation. Those who are self-employed can submit federal tax returns, while commissioned people and independent contractors might also offer Form 1099s, which state their gross income for the prior period from each income source. In some cases, 12 to 24 months of bank statements may be requested that show all income for the required period.

Warning

Substitute documentation does not negate the need for a mortgage credit report. In the conservative lending environment that followed the recession, with most subprime loans having met the same fate as that of the dinosaurs 65 million years ago, a negative credit report will still prohibit financing. A borrower's fair or poor credit score will typically restrict financing regardless of the income documentation that is offered.

Significance

While the statistics show that subprime loan products were often abused during the wildest years of the housing boom, Alt-A loans are important to the real estate industry. With small businesses and independent contractors representing more than 95 percent of the U.S. commercial economy, Alt-A mortgage products remain significant contributors to the housing industry and individual borrowers. A sole proprietor or independent contractor, such as a freelance writer, a software or website design consultant, or even a small restaurant owner simply cannot produce a W-2 since it does not exist. These borrowers need an accepted method to prove their ability to repay loans.

Considerations

All those who are not regular employees of companies need to consider the requirements and realities of Alt-A loans. People in this category should keep detailed records of income and expenses and carefully file their income tax returns. Those who receive 1099 forms--also sometimes called third-party verification of income--should save all other income and expense data to answer monthly income questions that may come from lenders. Understand that the loans offered will typically involve interest rates a bit higher than those available for conforming loans and some terms may be less advantageous. Lenders statistically assume higher risk with Alt-A loans and borrowers must pay a bit of a premium to account for this issue.