Stating the case for stated-income loans

First published in The Daily Record, July 13, 2009

Let me state my case for bringing back the stated-income loan.

OK, I hear the incredulous screams of: “You’ve got to be kidding me. That why we’re in the mess in the first place.”

To a certain extent, that’s true. The misuse and loosened guidelines for stated-income loans prior to August 2007 was widespread throughout the industry. What became known as “Liar Loans,” because income was just stated and never validated, has virtually vanished from the lending community. But the question is: “Has the pendulum swung too far in the other direction?” I think it has.

First, let’s get to the core of why stated-income loans were introduced. The primary use for stated-income loans was to allow those borrowers who were self-employed and did not receive a weekly or bi-weekly paycheck to state their income.

I used to tell self-employed borrowers that they probably had a wonderful accountant or CPA whose main job was to shield their income as much as possible from the IRS. Their job was to show the federal government that my borrower had very little taxable income. And when they showed their tax returns, that was the case.

I, on the other hand, am in the business of showing my underwriters that my borrower makes a significant income that qualifies him for a loan. Basically, the accountant and I are on opposite sides of the spectrum. These were borrowers whose income fluctuated from month to month or season to season.

For example, take a landscaper, whose makes most of his money during the spring and summer and sees his income tail off in the fall and winter. During part of the year, this borrower may be cash rich, but how do you document his or her income. In reality, the individual’s income could support the loan for the home the borrower would want to purchase, but it was nearly impossible to document the real income. The individual got paid in cash and personal checks. The adjusted gross income on that person’s tax returns would show he or she was dirt poor — even though that may not be the case because the individual had very healthy bank accounts. Therefore, if the borrower had the proper credit scores and assets, this would be the perfect stated-income borrower.

Since there was more risk involved with originating this particular kind of loan, the borrower would pay a slightly higher interest rate than the fully documented borrower.

Those kinds of loans seemed to be working out, so now investors and Wall Street got the bright idea that stated-income loans should be opened up to salaried workers as well. Why? If you have an engineer making a weekly paycheck, why do you need stated income? It was just a way to expand the pool of borrowers, and now we see that was a critical mistake.

So when the mortgage meltdown happened and stories came out about ill-qualified borrowers getting homes that they never could afford by virtue of a stated-income loan, that was that. No more stated-income loans for anyone. It was like being in that junior high classroom where a few of the kids were caught goofing off and all of a sudden the entire class gets detention.

The outlawing of these loans has made it almost impossible for many self-employed or “1099 employees” to qualify for mortgages even though in reality they generate a substantial income. In fact, Maryland has basically made it illegal to originate a stated-income loan.

So what to do? How do you resuscitate them? First, these loans must only be used for the kind of borrower that they were originally intended for — self-employed workers and business owners. Next, ensure that the self-employed borrower also has exceptional credit, with a credit score of at least 720. Finally, increase the number of months of bank reserves (money left over after settlement to pay the monthly mortgage) a stated-income loan borrower must show. At least six months would be good.

These people are the victims of unintended consequences. Yes, stated-income loans were abused, and that abuse caused much harm in the industry and to neighborhoods, but at some point common sense must return to the marketplace. It’s time for the pendulum to start swinging back — at least a little bit.

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