The higher mortgage rates, coupled with a tighter lending environment courtesy of Dodd-Frank, seem to act as a backdrop for stated income loans to stage a full comeback. Consumers may have been hoping for more variety in mortgages with less stringent guidelines. Liar loans, low doc loans, however they were called back then, stated income loans have quietly returned and served that purpose for a niche group of borrowers.
Less Risky Stated Income Loans
Pre-mortgage crisis stated income loans lived up to their name. Borrowers state (overstate) their income and lenders skip the verification part. Nowadays, the lender has to verify the employment and assets of a stated income borrower.
One lender, for example, will review the pay stubs and tax returns for salaried employees and business and personal tax returns for the self-employed. Similar to stated income loans, bank statement loans usually require a year’s worth of bank account transactions to see if the borrower is generating positive cash flows.
These measures serve to lessen risky lending practices. For the lenders, they have to make legal representations about the loan and could face a lawsuit if they have not done the appropriate due diligence.
Lenders also have more advanced automated systems to help them underwrite loans, checking if the loan application makes sense and complies with existing regulations.
A Return to ARMs?
The problem of the past stated income loans was their features that only added risks to an overstated income. Most of them had variable rates, which would be difficult to grasp with their caps, limits, margin, etc.
Some stated income loans were option ARMs under which the borrower can pick how he/she will pay back the loan in interest-only payments, minimum payments, 30- or 40-year amortizing payments, or 15-year amortizing payments.
The first four options called for really low monthly payments so less equity was built into the loan at the onset. Some of these loans didn’t even have down payments. This negative equity and falling home prices led to widespread foreclosures.
Stated income loans nowadays are still offered in variable rates but they also come in fixed rates. Fixed-rate mortgages offer stability and are easier to manage.
Interestingly, the current state of mortgage rates has made ARMs appealing because they offer lower rates than FRMs. They start with fixed rates until they adjust once a year. They’ve been an option for those who plan to move out or sell the home once the fixed rate period is over.
Stated Income Loans Serve a Niche
The Dodd-Frank Act ensures that the subprime mortgage crisis won’t happen again. But it has made access to mortgage credit even tighter for those who have trouble verifying their true income. These same people often apply for bigger loans.
Thus, the self-employed and the affluent turn to stated income loans as a specialized loan product for them. Alternative documents may be presented for employment verification; but higher down payments, better credit scores, and lower DTI ratios are required for stated income loans.