Are stated income loans BAD?
It seems like open season right now on lenders who have issued Stated Income loans over the last several years. Here is a brief introduction to stated income loans.
Historically, when applying for a mortgage, potential borrowers would take their paycheck stubs and the (hefty) down-payment to their local bank, sit down with a loan officer and a stack of forms and begin the process of loan qualification. The bank would consider the credit profile of the borrower, the capacity to repay the mortgage (income) and the collateral securing the bank's interest in the loan. These have been referred to as the Three C's, although I have heard of the Four, Five and even Six C's of mortgages, depending on which training program you look at. Based on a set of guidelines, a loan application will be approved or denied based on easy to define characteristics. This is a pretty straight-forward process, but is based on a complete understanding of a borrower's earnings as documented by W-2s and paycheck stubs.
Now let's consider a self employed borrower. Income calculations are suddenly much more complex, sometimes even impossible. The IRS will determine income based on your tax returns, but a self employed borrower has deductions which reduce his/her taxable income which a wage-earner will not have. Although the money deposited to each bank account could be identical in both cases, the taxable income can be drastically different. When you consider the number of people who have multiple jobs, or receive income that is difficult to verify (paid in cash) then it is easy to understand how the traditional mortgage qualification process does not fairly evaluate the ability of a potential borrower to repay the loan.
The beginnings of the reduced documentation loan reflected a shift towards stricter Credit and Collateral considerations and less stringent Capacity evaluation. Since these loans involved more risk, the rate reflected a higher profit potential for the lender, and we now have a reduced documentation loan. Don't believe the hype that just because there were less stringent documentation requirements that these were bad loan products. Typically, the credit standards are much higher in terms of FICO score and qualifying tradelines, and the properties are reviewed more intensely as well. The problem with many of these loans revolves around the willingness of borrowers and/or loan officers to inflate the income in order to qualify borrowers for larger loans. THIS IS FRAUD AND WAS NOT THE REASON BANKS ISSUED REDUCED DOC LOANS. To make matters worse, most of these mortgages are Adjustable Rate Mortgages (ARM's), so now we find borrowers who really couldn't afford the loan faced with rising interest rates making these loans even less affordable. When coupled with 100% financing and lower property values, we now have the "Perfect Storm". Borrowers who have no/limited down-payment at risk are much more likely to walk away from the problem. Without the ability to refinance, due to higher rates and/or decreasing property values, there really aren't many options for a lot of these situations.
Could this have been prevented?
Looking back, there are some obvious factors which certainly compounded the problem and we are currently seeing corrections in the mortgage market to move back to stability. Going back to our Three C's, we are seeing more stringent guidelines in each area.
•ü Credit: score requirements are higher now than in the recent past, especially for the best interest rates.
•ü Capacity: Most lenders have ceased issuing stated loans, especially for borrowers who are NOT self-employed or do not derive most of their income from self-employment
•ü Collateral: SHOW ME THE MONEY! Expect to bring a down-payment. The 100% loans for first-time homebuyers with limited credit, limited assets and who cannot document sufficient income have gone away.
About the Author: Brian Piper is a Senior Loan Officer with East West Mortgage in Vienna Virginia, one of the largest brokers in the country. Also on the web at www.VirginiaLoanPro.com