Without the agency guarantee, non-agency debt tends to pay a higher interest rate and offer these REITs a larger spread than agency REITs. Of course, this higher return comes with default risk, which is significant in the present market. Some non-agency debt is collateralized by the underlying property, while other debt is non-recourse. Non-agency REITs also employ differing levels of leverage and hedging techniques. All these issues add risk and uncertainty to the asset class, but also greater present yield.
Types of Non-Agency Mortgages
- Prime mortgages: High-quality mortgages that meet rigorous underwriting requirements, similar to those used for agency mortgages. Such loans are usually non-agency because the balances are above what Fannie and Freddie allows. Prime mortgage loans have historically carried low default risk because they are usually made to high-credit quality borrowers.
- Alternative-A (Alt-A) mortgages: Alt-A loans are usually provided to borrowers with average or above average credit scores, and have historically required looser loan documentation requirements and allowed larger loan sizes than under agency underwriting guidelines.
- Option Adjustable Rate Mortgages (Option ARMs): Option ARMs are a specific hybrid type of Alt-A mortgage that has flexible repayment terms. Option ARM mortgages allow for interest-only payments and sometimes even less than interest due payments. The loan balance of an Option ARM can increase over time (negative amortization in lending jargon). Such loans are designed to start with an exceedingly below average rate of interest, usually called a teaser rate, to attract borrowers.
- Subprime: Subprime mortgages are provided to borrowers with low credit ratings due to a damning or limited credit history. Subprime mortgages usually require minimal income and asset verification and carry high default risk. Lenders usually charge Subprime borrowers a higher than average interest rate.
The following six REITs have exposure to non-agency paper to varying degrees and
