An alternative A-paper, or Alt-A loan, is a type of mortgage classification that falls between a prime mortgage and a subprime mortgage. Let’s take a closer look at what an Alt-A loan is and how it works, so you can determine if it makes sense for your situation.
Definition and Example of Alt-A Loans
Alt-A loans are nonconforming loans designed for borrowers with good credit who don’t have the appropriate loan-to-value ratio or loan documentation for a conventional or government-backed mortgage. Most Alt-A loans meet the following criteria:
- Credit score: While the borrower may not have a perfect credit score, it’s typically below 660 or falls in the subprime range.
- Documentation: The borrower lacks proper or sufficient documentation that confirms their employment, income, assets, and liabilities.
- Debt-to-income ratio: It’s likely that the borrower’s debt-to-income ratio is higher than average.
- Loan-to-value ratio: The borrower may take out an Alt-A mortgage with a low down payment.
It’s important to note that there is no hard and fast definition of Alt-A loans, as their meaning is based on each lender’s specific requirements. Even credit-score minimums vary from lender to lender.
- Alternate name: Alternative A-paper loans
Even though an Alt-A mortgage is riskier than a prime mortgage, many lenders don’t mind them, as their borrowers have a solid credit history and therefore are likely to repay them.
How Alt-A Loans Work
If you take out a conventional mortgage, you’ll have to come up with a substantial down payment and submit documents that show your employment, income, assets, and liabilities. With an Alt-A loan, the lender probably won’t require you to share your tax returns, W-2 forms, and paystubs. Instead, they might look at 12 or 24 months’ worth of your bank statements to decide whether to approve you.
Also, you may be able to take out an Alt-A loan with little to no money down. In addition, you could get away with a higher debt-to-income ratio than you’d be able to if you opted for a conventional or other type of mortgage.
Depending on the lender and your unique criteria, you may be able to secure an Alt-A mortgage that allows for interest-only payments. This means you’ll only pay interest (not the principal) for a certain period of time, usually the first few years of the loan term.
An Alt-A mortgage may also feature a payment-option ARM, where you choose your payments each month. If you go with a payment-option ARM and your balance gets too high, the lender may convert your mortgage into a fixed-rate loan and significantly increase your monthly payments.
Alt-A loans tend to come with higher loan balances than conventional or other mortgage products do.
Pros and Cons of Alt-A Loans
Before you consider taking out an Alt-A loan, keep these advantages and drawbacks in mind.
Minimal or alternative documentation requirements
Flexible down payments
Good credit needed
Not available everywhere
- Minimal or alternative documentation requirements: If you’re self-employed, don’t work a traditional job, or have recently faced a lifestyle change that affects your finances, such as divorce, you may be able to forgo the typical documentation required with a conventional mortgage.
- Flexible down payments: Many lenders will approve you for an Alt-A loan even if you can only put a little or no money down. This is good news if you’re short on cash or don’t feel confident you can save for a significant down payment.
- Good credit needed: Even though lenders that offer Alt-A loans have lenient requirements, they’ll likely ask that you have a good credit score. This can be a drawback, if you don’t have the best credit history.
- Not available everywhere: Not all lenders offer Alt-A loans, so you may have to do a lot of research to find them. They were initially a “complement product” offered by traditional lenders that focus on prime mortgages.
Due to the increase in house prices at the time, Alt-A and other non-traditional mortgages were extremely popular between 2001 and 2005. When prices drastically decreased in 2007, delinquencies and foreclosures increased.
- While Alt-A loans are higher-quality than subprime mortgages, they don’t meet the standards to be classified as prime mortgages.
- Compared with other types of mortgages, Alt-A loans are characterized by minimal or alternative documentation, and may permit a smaller down payment.
- Alt-A loans may make sense for self-employed borrowers or those who have recently gone through a life event such as a divorce who might not qualify for a conventional or government-backed mortgage.