Stated income loans were huge contributors to the housing crisis, but they are making a very quiet reappearance in the housing market. Should the industry be concerned?
As originally designed stated loans were rational vehicles for borrowers that have a lot of assets, income, are self-employed, and have a lot of corporate records and tax records. The drama with these loans began just before the housing crisis when borrowers were no longer stating what they earn. but instead, stating what it takes to get the loan, while lenders did not take the time to properly underwrite these loans.
Ann Fulmer, Senior Industry Advisor for FormFree, discusses how these loans were misused prior to the crisis, the new emergence of these loans now, and how lenders should properly administer these loans.
MReport: There is an increasing amount of evidence that stated income loans or so-called “liar loans” are mounting a comeback. Is this true, and if so, why now?
Fulmer: The reason that these loans are coming back is because the majority of the lending industry is very cautious about mortgage loans because of the qualified mortgage (QM), the ability-to-repay (ATP) rule, and TRID. Stated income loans don’t fit into those boxes but they are making a comeback because many borrowers –especially in the jumbo loan space--have all kinds of assets and stellar credit, but they can’t qualify under ATR because of income. When people that are self-employed are living off the cash flow from a business they may reduce their taxable income by reducing the amount of money that is classified as income. While that may be a good strategy for reducing tax liability, it can cause problems when trying to qualify for a mortgage. Stated income loans, properly underwritten, are useful for borrowers who don't fit into the QM or the ATR box. The loans in today's market are at quality levels that are unheard of in part because today’s technology allows lenders to go directly to the custodians of relevant depositories to obtain 100 percent accurate information about the borrower.
MReport: After all that has happened with the financial crisis, do you think there is a place for such products in the market? Why or why not?
Fulmer: I do. Not all borrowers will fit into the QM/ATR boxes, especially when they’re self-employed or if they’re seeking a jumbo loan. Stated loans are not inherently problematic. If they are properly underwritten, with the appropriate amount of due diligence and verification, lenders are making their decisions based on accurate data so those loans are likely to perform well
Part of what happened during the housing boom was that there was so much pressure to increase volume that underwriting standards were reduced to where they had the rigor and strength of wet tissue paper. That was compounded by using stated loans for borrowers who had W-2s and by layering risk: stated income, plus adjustable rate mortgages with introductory teaser rates, plus 100 percent financing equaled disaster. That kind of risk layering has been outlawed so stated loans are once again a much safer niche product. The industry has refocused on quality. Technology has been advancing and it is empowering better lending decisions by going directly to the source of the critical data. Directly sourced data removes any possibility that a lender will end up with forged bank statements or misrepresented income. It also eliminates transposition and other errors that occur when application data is manually transferred from a loan application to a loan origination system. I am not saying that down the road people may not find ways to abuse stated loans but right now, in this environment, these loans serve a special purpose in the market and it’s OK so long as they are being underwritten appropriately.
MReport: Assuming stated income or so-called "low-doc" loans are back, what steps can and should be taken to mitigate the risk? At what point do lenders draw the line of trust with the consumer?
Fulmer: One of the things that has happened is that pre-collapse, underwriters had very little time to make a decision. Now, every time lenders originate and underwrite a loan, they are making legally binding representations about that loan's characteristics. Lenders don't want anyone that comes through the door and hands them a loan file to make that decision so they’re increasingly turning to automated systems. In order to protect themselves, lenders must make sure all compliance T's are crossed and all compliance I's are dotted. That focus on compliance means that the industry is not as focused on fraud as it should be.
One of the key ways to avoid fraud is to give underwriters enough time to step back and ask whether the application and the story it tells about the borrower make any sense. When you apply automation to the process, the efficiencies and the cost savings are tremendous. An efficient automated process that stops fraudulent and inaccurate information from getting into the system creates enough time for underwriters to critically analyze the application as a whole. Leveraging training, awareness, technology, tools, and high standards are how lenders and underwriters maintain quality and fight fraud. As for trusting borrowers, I can't speak for all lenders, but a wise lender is a lender who trusts but verifies.