The Return of Stated Income Loans
Small business owners and the self-employed who have difficulty being approved for a traditional home mortgage because they can't provide pay stubs or tax returns to show their income are getting some relief.
Stated income loans are being offered by companies such as Unity West Lending and Westport Mortgage, according to a Reuters story, giving such borrowers a chance to buy properties that they could rent out. Also called "liar loans" before the housing bust, the loans have gotten a bad rap because some borrowers produced fake bank statements or at least "fudged" their income to buy houses they couldn't afford.
Instead of having to provide tax returns or pay stubs, stated income loans require demonstrating an ability to repay through verifiable bank or brokerage statements and enough assets to make six to 12 months of payments.
Still, the loans have a place in the lending environment, mainly for self-employed people just starting out and small business owners with startups, says Bennie Waller, a professor of finance and real estate at Longwood University in Farmville, VA.
"However, lenders may be venturing down a road that was a contributing problem to the housing crisis," Waller says.
Higher costs for borrowers
The loans are riskier and require a higher interest rate for the borrower and a higher yield to the lender, he says. It's likely that stated income loans will be offered through high yield lenders and not from the big banks, Waller says.
They can also require high credit scores and bigger down payments. Greg Cook, a mortgage consultant at the First Time Home Buyers Network, says he worked for a mortgage company that pioneered stated income loans, and that they were available only to self-employed borrowers with at least a 720 credit score and 20 percent down payment.
Cook no longer works for the mortgage company that pioneered stated income loans. The company started doing them in 2002 during the bubble years "and when the competition witnessed their performance that was the beginning of the rush into stated income loans," he says.
"The key to the growth of stated income loans was getting the secondary market to accept them," Cook says. "Stated income had been around since the early 80s but never became mainstream until the investors in the secondary market bought into them."
The company stopped offering them in mid-2007 when the secondary market lost its appetite for them, he says.
Many emerging lenders are starting to offer stated income loans with bank statements instead of tax returns to document the ability to afford the loan, says Casey Fleming, a mortgage professional who has written a few such loans.
They carry a premium interest rate of about 3 percent more than a conventional loan, Fleming says, which is the ceiling under Consumer Financial Protection Bureau rules to avoid classification as a "high-cost mortgage" that can trigger all sorts of other risk issues. A 4.5 percent conventional loan for a premium-credit borrower turns into a 7.49 percent stated income loan for the same borrower, he says. "A high price to pay, but worth it if you really want the house," Fleming says.
Ability to repay in question
But the enactment of qualified mortgage and ability to repay rules in the Dodd-Frank Act stopped such loans for most home buyers, Cook says. Without proving the capacity to repay a borrower, lenders could be sued for unfair lending practices and be liable for up to three years of finance charges and fees.
"There are still some non-QM stated income loans available, but the interest rate and down payment requirements can be prohibitive for most home buyers," Cook says.
But the ability-to-repay rules only apply to people living in the house. Borrowers who are renting out the house, however, aren't subject to the repay rules and could be talked into mortgages they can't afford.
For borrowers who can't document income or who don't take much salary from their companies, stated income loans can make sense, if they can afford them, says Nicole Boyson, an associate professor of finance at the D'Amore-McKim School of Business at Northeastern University in Boston.
"In spirit, these loans make sense for people who fit these criteria and are unlikely to ever qualify for a regular mortgage due to unpredictable income," Boyson says.
However, it's possible for a borrower to get in over their head if they don't do a realistic cash flow projection to make sure they can afford the payments, she says. "Borrowers should not rely on banks or mortgage companies to tell them what they can afford, but should do their own analyses," she says.
"Bottom line, these loans may appeal to some borrowers," Boyson says. "But their high costs would lead me to recommend that a borrower wait a few years until their income is more stable, and then apply for a traditional loan."