In case you didn’t notice, stated income loans – also sometimes known as “low doc,” “no doc” or “liar loans” – are quietly making a comeback.
For example, New York City-based Quontic Bank recently rolled out “Lite Doc,” a five-year, adjustable-rate mortgage that requires only verification of employment and two months worth of bank statements. For self-employed borrowers, it requires documentation of one year of profit and losses.
However, “Lite Doc” is nothing like the “low doc,” “no doc” loans that were so prevalent during the pre-crisis years. As per a recent report on CNBC.com, the product is only for owner-occupied properties; requires a 40% down payment; and borrowers must have a minimum FICO score of 700. In addition, borrowers must show that they have a minimum of 12-months worth of principal, interest, taxes and insurance in the bank at closing.
So, how did these loans start sneaking back into the marketplace? As explained by Ann Fulmer, senior industry advisor for FormFree Holdings, a provider of automated asset verification solutions, what really makes today’s “low doc” mortgage offerings different from the ones of the past is not just the lending criteria, but also how borrower data is collected and verified.
“I think it’s important to remember that stated income loans are not inherently bad products,” Fulmer, a nationally recognized fraud expert, tells MortgageOrb. “The reason they got the reputation as being ‘liar loans’ is because during the boom, instead of stating what you made, people were stating whatever it took to make the numbers work on the loan.”
In addition, stated income loans “were very risky because they had layered risk … They were often coupled with adjustable-rate mortgages, with negative amortization, pick-a-pay, the teaser rates, 100% financing, etc., and you put that much risk on a W-2 borrower who is overstating – it is a recipe for disaster,” Fulmer adds.
But when properly underwritten, stated income loans serve an important niche market: the borrowers that don’t fit into the credit box under the recently enacted qualified mortgage/ability-to-repay rules.
“And in particular, people who need jumbo loans or are self-employed,” Fulmer says. “That’s really what stated income loans were designed for – they were for wealthy, high-liquid-asset borrowers who qualified more on their assets than they did on their income. And when done properly, they’re fine.”
As Fulmer points out, stated income doesn’t mean unverified income – and it’s the verification piece that is the key difference when comparing the “low doc” loans of the pre-crisis years with the ones of today.
“The Consumer Financial Protection Bureau (CFPB) has made it very clear that lenders had better be originating good-quality loans that are going to perform,” she says. “In other words, that the borrower is going to be able to repay according to the terms. The difference now, I think, is that because of the CFPB’s regulations and the government-sponsored enterprises’ new rep and warranty frameworks – and the loan quality initiative of a few years ago – the industry has clearly gotten the message that regulators and investors want quality to be job number one. Now, instead of doing solely sampled quality control post-closing, the industry has finally gotten the lesson that you need to do your due diligence on a loan before you close it and certainly before you sell it off to the secondary market.”
When it comes to offering such products, it is really the technology that has made all the difference. As Fulmer explains, lenders now have advanced auto-verification tools that allow them to not only pull the data they need – in automated fashion – but also “perform on-the-fly analysis to help establish the identity of the borrower and the account holder … and what the actual income is.”
“For example, with ACH deposits, you can determine what a borrower’s actual income is – you can look at it money in, money out and what’s in reserves to see if there are any unusual spikes in deposit amounts, which might be indicative of someone fooling around with their down payment or cash reserves,” she says. “More importantly – and for the safety of everybody – a lender can also back into residual income or disposable income, which gives the lender a much clearer picture of a borrower’s ability to repay than a simple debt-to-income ratio because, generally speaking, the income they’re looking at [via bank statements] is gross.”
One of the things that’s great about today’s auto-verification tools is that they’re going directly to the source. They’re not pulling the statements – they’re pulling the data directly from the provider’s database. That’s really important because “bank statements and W-2s are among some of the most easily fabricated documents out there,” Fulmer says.
“Lenders that are relying on those documents are subjecting themselves to a significant amount of risk,” she says. “But when you go directly to the source, there is no chance that that’s going to happen. Also, because it’s all automated, you don’t have the transposition errors and other innocent mistakes that can happen when it’s a paper-based, manual process. When you go directly to the source, you get 100% accurate transfer of the information, as reported.”
Fulmer says the technology was available to do all of this in the pre-crisis years, “but the industry wasn’t ready to adopt it – because the world was crashing down around it.” Today, growth in the auto-verification solutions space is “like a vertical wall – it is just going straight up,” she says, not just because of the new focus on quality control and risk management, but also because of the tremendous business efficiencies that can be realized.
Because these tools are now Web-based – and also due to the fact that database integration has become so much simpler and faster in the cloud – today’s auto-verification solutions are fast and relatively simple to deploy.
“The cloud has made all the difference,” Fulmer says. “Because pretty much everything is available now – and it’s an amazing thing.”
This sea change in how income and assets are verified has also “led to lenders rethinking what a credit score is supposed to do,” she adds.
“A credit score represents a borrower’s propensity to repay – the likelihood that they will be able to repay,” Fulmer says, adding that some lenders have, in recent years, started de-weighting FICOs in their underwriting decisions (in fact, at least one lender said it was moving away from FICO entirely). “A credit report will also show you certain types of outstanding debt – but as we learned during the crisis, a FICO score is not necessarily an accurate predictor of loan performance, especially under extreme stress. It kind of amuses me because it’s like when you get a statement from a stock broker and it says ‘past performance is not an indicator of future performance.'”
One of the shortcomings of relying too heavily on a borrower’s credit report in making underwriting decisions is that it “does not show a lender all of the ongoing expenses that a borrower might have.”
“That’s one of the things that, when you go directly to the source and pull the data, [you can uncover more detail using analytics],” Fulmer explains. “For example, you might see a charge for $242.62 every month – it could be school tuition, it might be a student loan, it might be someone helping a child. So, there are expenses that won’t show up in a credit report – and if you really want to get at whether a borrower can afford a mortgage, you really need to get into residual income.”
It used to be that it took a lot of time to do that level of analysis – but now, underwriters get the info they need quickly from an automated system. Perhaps best of all, the data they’re using today is many times more accurate compared with what had been simply “stated” by borrowers in the past.