Do No Income Verification Mortgages Still Exist?
Imagine you want to purchase a home but your income is hard to verify. Maybe you’re a real estate investor who carries over passive losses that technically “erase” your earnings even though you have proven cash flow. Or, perhaps you work on commission and show huge swings in your pay — so much so that some months show no income at all.
In cases like these, there can be a huge disconnect between what your pay stubs and tax returns show and how much you actually earn. For that reason, scenarios like these are perfect for what has historically been known as a “no income verification mortgage.”
But, how do no-doc mortgages work? A no-doc mortgage loan is one where borrowers are not required by mortgage lenders to provide any income documentation to support their ability to repay the loan.
When these loans surged in popularity in the early 2000s, they were extremely helpful to a small percentage of workers with high incomes that could be hard to prove. Like with many programs that start out with the intention of helping consumers, however, no-doc loans became problematic when lenders realized they could use them for their own gain.
What happened to no-doc mortgages?
The problem with no-doc mortgages started around the time the housing bubble of the early 2000s was taking shape. While these mortgages were originally intended for borrowers with fluctuating incomes and good credit, many subprime lenders moved beyond prime borrowers with good credit and incomes to subprime borrowers and other borrowers with less than perfect credit or shaky income qualifications.
As with many things, no-doc mortgages started out as a specialized product but the product soon expanded and they started offering no-doc mortgages to such an extent that they ended up calling them “liar loans.”
Liar loans – a term used to describe home loans where the applicant would have to lie to qualify – became common in expensive markets where many people couldn’t get a mortgage for their preferred home if they presented an accurate picture of their finances. These loans defaulted in extraordinarily high percentages back then since borrowers couldn’t really afford them to begin with.
But, some lenders still kept making them. According to the Financial Crisis Inquiry Report, which was the final report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, low- and no-doc loans started going off in an entirely different direction around 2005. Realizing they could sell more loans if they loosened requirements, non-prime lenders started boasting how they could offer borrowers home loans without loads of paperwork in exchange for a higher interest rate.
From 2000 to 2007, no-doc loans more than quadrupled from around 2% of home loans to approximately 9% of all outstanding loans, according to the report.
While it may seem strange that banks would hand out loans to people who couldn’t afford them, lenders were incentivized to keep making these loans for a few reasons. First, loan officers still earned a commission regardless of whether the homebuyer defaulted on their loan or not. Second, mortgage lenders weren’t planning on keeping these loans on their books; instead they were repackaging these loans and selling them as mortgage-backed securities to investors.
Lenders made money on the origination of the loan, so they were trying to profit off of volume alone. It didn’t matter to them if the loan was good or bad as long as it went through.
The Financial Crisis Inquiry Report noted that, by the time the financial crisis of 2008 hit, investors held more than $2 trillion of non-GSE (not from a government-sponsored enterprise) mortgage-backed securities and close to $700 billion of CDOs (collateralized debt obligations) that held mortgage-backed securities.
At the same time, delinquencies on mortgages started to surge nationwide, but particularly in “sand states” including Arizona, California, Florida and Nevada. Serious delinquencies — or delinquencies where mortgage payments are more than 90 days late —peaked at 13.6% of mortgages in sand states and at 8.7% of all mortgages nationwide in 2009.
We all know what happened while all of this was going on. As mortgages defaulted nationwide, housing prices dropped. As housing prices dropped, more homeowners defaulted on their mortgages. The financial crisis continued spiraling out of control, influenced by the housing bust as well as other factors.
The end of ‘liar loans’
Numerous consumer protections were p ut in place in wake of the financial crisis of 2008, many of which were encompassed in the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was passed in July 2010. Reiss noted this act was envisioned as a way to reduce bad decision-making by lenders while also protecting consumers.
The Dodd-Frank “Ability-to-Repay” rule was of particular consequence to the mortgage industry since it ruled that lenders had to confirm the borrower could repay their loan.
This sounds ridiculous that you would have to tell a lender this, but it was needed. Since lenders were making equity-based loans, they didn’t care if a borrower defaulted. They only needed to verify the property had enough equity that they could foreclose and get their money back if a borrower quit making mortgage payments.
Lenders had to consider eight different factors under the new rule to determine a borrower’s ability to repay — their current or reasonably expected income or assets, current employment status, the monthly payment, monthly payments on other debts related to the home, monthly payments for mortgage-related obligations, other debt obligations, monthly debt-to-income ratio and credit history.
From there, a creditor had to make a “reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms,” stated the Ability-to-Repay Rule, Regulation Z Section 1026.43.
As the American Bar Association noted, the rule “applies to all residential mortgages including purchase loans, refinances, home equity loans, first liens and subordinate liens.” The rule does not apply to commercial or business loans, however. The rule also does not apply for loans that relate to timeshares, reverse mortgages, loan modifications and temporary bridge loans.
Are no-doc mortgages still available?
Some lenders are still making no-doc mortgages. However, credit expectations are significantly higher now and the loans are more expensive for consumers to get. Borrowers may need “very good” or “excellent” credit now instead of “fair” credit, and no-doc loans can come with a higher interest rate than a traditional home loan. Still, these loans are essential for borrowers with high but irregular incomes since even those who work on commission or the self-employed need to be able to borrow money for a home.
A lot of people have a low taxable income, too. It may be obvious from your bank statements that you generate a lot of cash, but that doesn’t mean it is reflected as a high income on your taxes. If a lender is just looking at the bottom line on your 1040s, it may not account for your actual cash flow after tax adjustments like depreciation and carried-over losses from previous years.
In addition, no-doc loans are still available for business purposes since commercial and business loans weren’t impacted by the post-housing crisis regulations.
Self-employed and no income verification mortgages
Fortunately, there are still ways to get a mortgage if you’re self-employed or have a fluctuating or hard-to-prove income.
Self-employed borrowers are certainly eligible for full document loans but they also have the option of bank statement loan programs not available to W-2 wage earners.
With this type of loan, self-employed borrowers may be able to use 24 months of bank statements to demonstrate a specific pattern of cash flow that meets the Ability-to-Repay requirement. In this case, you may need to provide additional documentation on top of your bank statements, such as proof of your other debts. You may also need to save up at least 20% of your home’s purchase price to qualify. However, there are a variety of formulas used by lenders to determine which type of documentation is required and other lending criteria.
Many self-employed borrowers have the ability to repay, but they are unable to demonstrate that with traditional use of tax returns due to extensive write-offs. A bank statement loan program can help them prove cash flow and income regardless of what their tax returns say.
There are some criteria that can help the self-employed or commission-based workers secure a mortgage, whether they opt to go with a traditional lender or pursue a no-doc loan.
- Save up a big down payment. You want to save up a big chunk of money to put down on your home — hopefully at least 20%. The bigger your down payment, the more likely you are to qualify for a home loan.
- Make sure your credit score is as high as it can be. You’ll need very good credit to improve your chances of getting a home loan with the best terms. Typically, “very good” credit includes any FICO score of 740 or higher. If your credit score is lagging, you should take steps to improve it such as paying down debt to lower your credit utilization and making sure all your bills are paid on time.
- Pay down debt to improve your debt-to-income ratio. Most mortgage lenders limit qualified mortgages to borrowers with a debt-to-income ratio below 43%. This means that all your debts including your housing costs must make up less than 43% of your gross income each month. If you earn $5,000 per month, for example, your monthly debts including your house payment should be less than $2,150.
- Get your tax returns together. It’s pretty standard for lenders to ask for two years of tax returns during the loan application process. However, you may not need two years of tax returns if you opt for a bank statement loan program.
No-doc mortgages may not be as prevalent as they once were, but you can still get a home loan if you’re self-employed or have a highly variable income. You’ll have to jump through more hoops to qualify, but you are protected from some of the predatory lending practices that were commonplace until the financial crisis.
Ultimately, changes made in the realm of mortgage lending such as the Dodd-Frank Ability-to-Repay rule were necessary to not only protect investors, but also borrowers. With stricter requirements in place, homebuyers are much less likely to end up in a home they can’t afford — although that often means borrowing less than they want.