The non-qualified mortgage (non-QM) sector is showing signs of growth even as mortgage rates continue to fluctuate, reflecting an increasing acceptance of alternative lending products among institutional investors.

Demand for non-QM products, including second mortgages and HELOCs, surged in the third quarter, with originations growing over 20% quarter over quarter, according to a recent MCT Trading report. Non-QM originations are also on the rise, as more institutional investors, including insurance companies, actively add these products to their portfolios.

This interest in non-QM loans is primarily driven by products like Debt Service Coverage Ratio (DSCR) loans, which are popular among institutional investors due to their higher potential yields.

“DSCR loans have become one of the most sought-after non-QM products by institutional investors,” the report noted.

Current fair values for non-QM mortgage servicing rights (MSR) range between 3.65x and 4.125x servicing fees, while second mortgages and HELOCs carry fair values of 2.30x to 2.85x.

“We anticipate this growth in these product segments to continue for the rest of 2024 and throughout 2025,” MCT wrote.

Rate swings shape market landscape

The 30-year base mortgage rate had risen to 6.9% as of October 31, up roughly 70 basis points from the end of September. This rate increase came after a period of cuts during Q3, which briefly pushed mortgage rates lower, fueling a spike in prepayments for 2023 loan vintages.

While non-QM prepayments rose to the lower double digits, older vintages saw more moderate increases, generally remaining in the high single digits.

The report anticipates that existing portfolio fair values may increase by 3-6 basis points from their September 2024 marks, particularly for 2023 and 2024 loan vintages, which are more sensitive to rate changes. Meanwhile, 2020-2022 vintages are expected to show only minor value increases.

“Here we go again! Mortgage rates and all other rate indices continue their roller-coaster ride quarter after quarter,” MCT said. “After so much anticipation of lower mortgage rates to remain throughout the rest of 2024, rates took a sharp U-turn and are back up about 68 basis points from their lows on September 30.”

Read next: Mortgage rates are rising again. What’s next for the market?

Current rates are now close to their levels from July 2024, with the financial markets speculating that the Federal Reserve may lower the overnight rate by 25 basis points in November due to strong economic and job market performance. Nevertheless, mortgage rates are expected to remain relatively high through the rest of 2024 unless unexpected economic or political shifts occur.

Tamed expectations

Mortgage servicing rights (MSR) values took a hit in Q3, dropping by about 4-10 basis points, depending on portfolio specifics. This decline was driven by an 80+ basis point drop in mortgage rates and a 120 basis point decline in float income rates, resulting in MSR losses across the industry.

Yet, with rates rebounding, MSR values are expected to recover approximately 50% of Q3’s losses, as demand for MSRs remains robust due to low MSR supply and restrained production volume.

Increased prepayments, especially in 2022-2023 vintages, reflect the short-lived drop in Q3 mortgage rates. However, refinancing activity that had initially surged has since slowed in October. Many lenders, initially optimistic about lower rates, are now tempering expectations for rate declines and higher production as 2024 comes to a close.

“We continue to advocate caution when capitalizing new production as the market navigates the mortgage rates roller-coaster,” the report read. “Higher capitalization rates in this current and volatile rates environment could lead to fair value write-downs or impairments as we close 2024.

“All of the mortgage market euphoria about lower rates and higher anticipated increase in production has since evaporated. Lenders have tamed their expectations of lower rates as we come to the close of 2024. All eyes and hopes for lower rates have now shifted to 2025.”

The Mortgage Bankers Association (MBA) projected a 28% rise in mortgage production for 2025, with volume expected to reach $2.3 trillion. The MBA’s baseline forecast for the 30-year mortgage rate was 5.90% by the end of 2025, with 63.5% of production expected to come from purchase volume.

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