Reported Income Loans Destroyed the Housing Market in 2008. Here’s Why They’re Safe in 2021
Stated income loans were the main cause of the collapse of the US real estate market and the Great Recession that followed. They are making a comeback, but with major changes. If you are self-employed or a business owner, a stated income loan may be a good mortgage choice.
We spoke to Steven Schnall, CEO of Quontic Bank – a lender that specializes in serving outsiders – to understand why these loans are now a safe bet.
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Why cash flow loans needed a facelift
A stated income loan is exactly what it sounds like, a mortgage based on your stated (unverified) income. Before the real estate crisis, this type of mortgage was excessively abused.
“Reported and no-income loans have been used by salaried and self-employed borrowers, speculators, pinball machines, buyers with poor credit or no credit, and crooks,” says Schnall. Lenders did not verify employment, income, or assets, and borrowers could get mortgages for amounts they had no way to repay.
Some stated income loans allowed people to borrow a significant percentage of the value of the home. Up to 125%, in fact. When borrowers owe more than the property’s value, they have negative equity. They may feel trapped – unable to sell or refinance – and are more likely to default on their loans.
“Wall Street kept lowering the bar,” says Schnall. He explained that since the loans were salable in the secondary market, there was little incentive to tighten lending guidelines. The real estate world has seen a buying rush and house prices have been rising at a lightning pace.
It’s easy to see why the stated income loan was a recipe for disaster and the name now carries a stigma. Eventually, these mortgages became associated with massive default rates and the whole housing crisis.
Many borrowers cannot get a traditional mortgage
After the real estate crash, the government passed the Dodd-Frank Act with strict controls on who could qualify for a mortgage. He created a new, safer mortgage class called a Qualified Mortgage, or QM.
One of the main features of a QM is that the lender checks the borrower’s ability to repay the loan through income tax returns and W2s or 1099s. This requirement has excluded many people from mortgage loans.
Here are two examples.
There are up to 25.5 million independent U.S. taxpayers, according to Pew Research. Schnall says they often don’t qualify for the Dodd-Frank rules because they can’t document their income as required by a QM. It is not necessarily because an independent borrower is in financial failure. This may be because they minimize their taxable income by maximizing their legal deductions. Or maybe they invested in the business and posted a loss on last year’s tax return.
Buyers of investment property may also find it difficult to document sufficient income. Some real estate investors know that they will be able to cover the mortgage payment with the rent collected on the property. But they may not be able to prove sufficient income on their tax return to qualify for the loan, especially if they already have one or more home loans.
Income loan reported today
The stated income loans of today are a far cry from the risky loans of the 2000s. Indeed, Schnall argues that the default rates for well written reported income loans are very low.
To approve a home loan application, the underwriter looks at four main factors: borrower’s income, LTV, credit rating, and liquidity. The loan-to-value or LTV is the amount you borrow against the value of the property.
“If you take one of those four legs off, you need strength in the other three,” says Schnall. Cash reserves can often be met by the loan itself. As such, a borrower may qualify for a mortgage loan with a good credit rating and significant equity.
Schnall says he dived deep into historical data on pre-recession loan performance and found a default rate of less than 2% for loans with low LTVs and high credit ratings. . Industry research confirms this. According to the Urban Institute, a low LTV and good credit are the strongest indicators of mortgage creditworthiness.
“Skin in the game and good credit are strong indicators that you will be able to make your mortgage payments,” says Schnall. “In 10 years, we have never suffered a loss on a residential mortgage.
Who should consider a stated income loan?
A stated income loan, also known as an alt-doc loan, is just one type of non-QM home loan in the market for borrowers who need broader mortgage options.
Stated income loans are a good option for homebuyers who have cash or equity, but might find it difficult to document enough income to qualify for a traditional mortgage. For example, small business owners, concert workers, and people with fluctuating incomes.
Unlike qualified mortgages, which are based on documented income and set debt-to-income limits (DTI), stated income loans are based on equity and credit ratings. The income mortgage program shown is not a low down payment or bad credit mortgage. A first-time home buyer looking for low barriers to homeownership may be better suited with other options, such as an FHA loan.
There are a few tradeoffs with a stated income loan when compared to qualifying mortgages. The most obvious is the high down payment requirement. The other is that even for borrowers with excellent credit, the mortgage rate of a stated income loan is higher than that of a qualified mortgage loan.
Is a stated income loan safe?
Lenders have abandoned subprime lending features that were common before the real estate crisis. And borrowers with low LTVs and high credit scores are unlikely to default. As such, this type of mortgage can be beneficial to both the borrower and the lender. “Even through COVID,” says Schnall, “our borrowers have performed.”
The Consumer Finance Protection Bureau (CFPB) is also in the game. The CFPB is the watchdog body that protects consumers against unfair, deceptive and abusive financial practices. Its guidelines emphasize that even though a loan is not an MQ, it can still be an appropriate loan.