Stated income loans gained tremendous popularity in the 2000s. Pre-financial crisis, these loans let lenders skip verification of borrowers’ salaries and income documentation.
Prospective homebuyers quite literally just stated their incomes on the applications. While these types of loans might have been attractive to self-employed loan seekers who have a harder time attesting to and documenting steady streams of income, they also played a crucial role in bringing about the financial crisis.
What are stated income loans?
Before the financial crisis, stated income loans — also called “liar loans” because reported incomes were often inflated — were prevalent. For these types of home loans, borrowers didn’t need to submit the typical documentation like pay stubs, W-2s, tax returns or other forms of income verification.
All borrowers needed to do was state an income on their mortgage application in order to be approved, which led to a slew of false or inflated stated incomes. According to Freddie Mac, “a stated income loan is a loan where the income that is put on Form 65, Uniform Residential Loan Application, is not fully verified. A false stated income loan is any loan originated under a program in which the borrower’s income has been misstated for qualification purposes.”
Subprime mortgage lender Ameriquest — which was shut down in 2007 — was one of the big promoters of stated income loans, triggering the firm’s eventual downfall.
These loans were a major part of the collapse of the housing market in 2008 and the ensuing financial crisis. The combination of a lack of lending regulation, lax underwriting standards and irresponsible lending practices triggered high rates of mortgage delinquencies and foreclosures: A total of 7.8 million American consumers lost their homes through foreclosure in the wake of the crisis.
Today, delinquency rates on mortgages have fully returned to their pre-crisis lows and can be expected to stay low until the next economic recession, according to Tendayi Kapfidze, chief economist at LendingTree. “In quarter three of 2018, mortgage delinquency rates were 3.0%. This low delinquency rate is well below the 2010 high of 11.5% delinquency,” he wrote in a December 2018 MagnifyMoney article. (LendingTree owns Student Loan Hero and MagnifyMoney.)
Can you get a stated income loan today?
Today, stated income loans are extinct. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act went into effect, ending them.
Section 1411 of the act states that “a creditor making a residential mortgage loan shall verify amounts of income or assets that such creditor relies on to determine repayment ability, including expected income or assets, by reviewing the consumer’s Internal Revenue Service Form W-2, tax returns, payroll receipts, financial institution records, or other third-party documents that provide reasonably reliable evidence of the consumer’s income or assets.”
In 2013, the Consumer Financial Protection Bureau (CFPB), which is charged with implementing the act, adopted a further rule — the ability-to-repay rule — to protect consumers from irresponsible mortgage lending by requiring lenders to ensure prospective buyers have the ability to repay their mortgage.
The CFPB’s rule also protects borrowers from certain risky lending practices that contributed to people losing their homes. According to the rule, lenders can no longer offer no-doc or low-doc loans, also known as “Alt-A” loans. With these loans, lenders were able to make quick sales with no documentation required — before offloading the risky mortgages onto investors.
In addition, lenders are presumed to have complied with the ability-to-repay rule if they issue qualified mortgages (QMs). Qualified mortgages must meet certain requirements that prohibit or limit the risky features that harmed consumers in the mortgage crisis, including no excess upfront points and fees, no toxic loan features, a cap on how much income can go toward debt and no loans with a balloon payment (except those made by smaller creditors in rural or underserved areas).
However, some lenders are still trying to cater to the self-employed prospective homeowner market segment, and are now offering loans that seem to bear some similarities to stated income loans. For example, so-called bank statement loans are an alternative. For these loans, lenders typically analyze 12 to 24 months of bank statements to determine the ability to repay, instead of the traditional tax documents.
How do you find loans with flexibility on income?
So what does this mean for consumers looking for non-conforming or non-qualified mortgage (non-QM) loans?
Non-QM loans are loans that don’t comply with the CFPB rule on qualified mortgages. They typically come with more demanding requirements, including higher credit scores or greater down payments.
But according to Tom Hutchens, executive vice president of production at Angel Oak Mortgage Solutions, these loans are 180 degrees different from the pre-financial crisis stated income loans.
“In addition to bank statements, we also look at the borrower’s credit history, whether they paid bills on time, we look at assets they have, and reserves in the bank, which we require,” he said. “So if there’s a bump in the road with their business, they still have money in the bank to repay the loan.”
Hutchens also noted that Angel Oak will typically turn down a potential borrower if their credit history or the income shown on their bank statements doesn’t support the ability to repay.
What this means concretely is that Angel Oak looks at the prospective borrower’s income stream over 12 months and averages it. Then, Angel Oak looks at their debt, including their debt-to-income (DTI) ratio, which is the relationship between a consumer’s monthly debt payments and money coming in. Most mortgage lenders limit qualified mortgages to borrowers with a DTI below 43%. Fannie Mae, for example, imposes maximum DTIs of 36% to 45%, depending on the applicant’s credit rating and down payment. A non-QM lender like Angel Oak, on the other hand, could have a 50% cap for total DTI.
According to Ben Wu, executive director of LoanScorecard, the growth of the gig economy is contributing to the development of bank statement loans and other non-QM programs for borrowers who don’t necessarily fit in the traditional, conventional mortgage box.
“It should be noted that these loans are well-documented and fully underwritten,” Wu said. “Also, instead of 10% post-closing quality control, there’s usually a 100% third-party review performed by a due diligence firm in order for the loans to participate in non-agency securitization. Thus far, these loans have performed well, with extremely low delinquency or default rates.”
How to get a loan if you’re self-employed
Beyond bank statement loans, other non-QM loans available to self-employed prospective homebuyers are few and far between.
One alternative is an asset-based loan. Angel Oak, for example, requires a minimum of $500,000 in assets to qualify for one. While each lender has its own guidelines to meet the “ability-to-repay test,” these asset-based loans have higher requirements to meet and hence cater more to high-net-worth individuals.
“There is a big demand and need in the marketplace for highly qualified self-employed borrowers as they’ve been cut out since the crisis,” Angel Oak’s Hutchens said.
Karan Kaul, research associate, Housing Finance Policy Center at the Urban Institute, echoed the sentiment.
“It’s incredibly hard for self-employed folks as they have to deal with additional documentation requirements,” he told Student Loan Hero. “With non-QM loans, the risk is elevated, and most lenders are shying away from that risk.”
According to Kaul, while the non-QM market can be a perfectly “decent option,” it still does not benefit from the same protections for borrowers because lenders don’t have to abide by the same restrictions, such as no toxic loan features and no excessive upfront points and fees. “There is definitely a niche borrower segment, but we’re not there yet. The market for lending outside of QM is really tiny,” he said.
With the extinction of stated income loans, self-employed borrowers must rely on a few alternatives, such as tax returns and bank statements, for loan eligibility.
While non-QM loans are an option, know that because they don’t fall under the QM umbrella, they are not as well-protected. In addition, to counterbalance the lack of verifiable — by traditional means — steady income, lenders can ask for “compensating factors,” which may include a bigger down payment.
As the Urban Institute’s Kaul said, non-QM loans carry prescriptive requirements that are “difficult to satisfy and likely make it harder for self-employed households to obtain mortgages.”