Stated Income Loans Wrecked the Housing Market in 2008. Here's Why They're Safe in 2021
Learn what a stated income loan is and who might benefit from using one.
Stated income loans were a primary cause of the collapse of the U.S. housing market and subsequent Great Recession. They are making a comeback, but with major changes. If you're self-employed or own a business, a stated income loan may be a good mortgage choice.
We spoke to Steven Schnall, CEO of Quontic Bank -- a lender that says it specializes in serving the underdog -- to understand why these loans are now a safe bet.
Why stated income loans needed a facelift
A stated income loan is just what it sounds like, a mortgage based on your stated (not verified) income. Prior to the housing bust, this type of home loan was abused to excess.
"Stated and no-income loans were used by salaried and self-employed borrowers, speculators, flippers, buyers with poor credit or no credit, and scammers," says Schnall. Lenders didn't verify employment, income, or assets, and borrowers could get mortgages for amounts they had no way of paying back.
Some stated income loans allowed people to borrow a large percentage of the home's value. As much as 125%, in fact. When borrowers owe more than the property is worth, 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 saleable on the secondary market, there was little incentive to tighten lending guidelines. The real estate world saw a rush to buy and home prices rose at lightning speed.
It's easy to see why the stated income loan was a recipe for disaster and the name carries a stigma now. Eventually, these mortgages became associated with massive default rates and the entire housing bust.
Many borrowers can't get a traditional mortgage
After the housing market crash, the government passed the Dodd-Frank Act with strict controls on who could qualify for a mortgage. It created a new, safer class of mortgage called the qualified mortgage, or QM.
One of the main features of a QM is that the lender verifies the borrower's ability to repay the loan via tax returns and W2s or 1099s. This requirement shut many people out of home loans.
Here are two examples.
There are as many as 25.5 million self-employed U.S. taxpayers, according to Pew Research. Schnall says they often don't qualify under Dodd-Frank rules because they can't document their income the way a QM requires. This is not necessarily because a self-employed borrower is financially unsuccessful. It could be because they minimize their taxable income by maximizing their legal deductions. Or perhaps they invested in the business and show a loss on last year's tax return.
Investment property buyers can also struggle to document sufficient income. Some real estate investors know they'll be able to cover the mortgage payment with the rent received on the property. But they may not be able to show enough income on their tax return to qualify for the loan, especially if they already have one or more home loans.
The stated income loan today
Today's stated income loans are a far cry from the risky loans of the 2000s. Indeed, Schnall says default rates for well-underwritten stated income loans are very low.
To approve a home loan application, the underwriter looks at four main factors: borrower's income, LTV, credit score, and liquidity. Loan-to-value or LTV is the amount you borrow against the value of the property.
"If you take away any one of those four legs, you need strength in the other three," says Schnall. Cash reserves can often be satisfied by the loan itself. As such, a borrower can qualify for a mortgage with a good credit score and significant equity.
Schnall says he took a deep dive into historical loan performance data pre-recession and found a default rate under 2% for loans where there was low LTV and a high credit score. Industry research bears this out. According to the Urban Institute, 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," Schnall explains. "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 called an alt-doc loan, is just one type of non-QM home loan on 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 struggle to document sufficient income to qualify for a traditional mortgage. For example, small business owners, gig workers, and people with fluctuating incomes.
Unlike qualified mortgages, which rely on documented income and set debt-to-income (DTI) limits, stated income loans rely on equity and credit scores. The stated income mortgage program is not a low down payment loan or a mortgage for bad credit. A first-time homebuyer looking for low barriers to homeownership may be better suited to other options, like an FHA loan.
A stated income loan does come with a couple of trade-offs compared to qualified mortgages. The most obvious is the high down payment requirement. The other is that even for borrowers with excellent credit, the mortgage rate on a stated income loan is higher than on a qualified mortgage.
Is a stated income loan safe?
Lenders have dropped the risky loan features that were common prior to the housing bust. And borrowers with low LTVs and high credit scores are unlikely to default. As such, this type of mortgage can be good for both the borrower and the lender. "Even through COVID," says Schnall, "our borrowers have performed."
The Consumer Finance Protection Bureau (CFPB) is on board, too. The CFPB is the watchdog agency that protects consumers from unfair, deceptive, and abusive financial practices. Its guidance points out that even if a loan is not a QM, it can still be an appropriate loan.
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