What happened to stated income loans?
Stated income loans are widely recognized as one of the primary factors that caused the housing market collapse between 2007 and 2010. These so-called “liar loans” didn’t require any form of income verification and ultimately allowed borrowers to take out loans they simply could not repay.
Are these loans making a comeback? And, if they are, are they any safer now than they were pre-crisis? This article explains how the definition of stated income loans has changed over time, when loans with alternative underwriting standards make sense, and how you can find these loans.
- What is a stated income loan?
- What happened to stated income loans?
- Can you still find a stated income loan today?
- Self-employed borrowers
- Real estate investors
- Do stated income loans make sense for you?
What is a stated income loan?
In the past, stated income mortgages were home loans where lenders did not verify or document income at all, and were called stated income loans because lenders used the income stated on a loan application to issue a loan. Stated income loans started to rise in popularity in the early 2000s.
“In the early days of stated income loans, they were popular among self-employed borrowers. These were borrowers who couldn’t fully document their income,” explained Tom Hutchens, SVP of sales and marketing for Angel Oak Mortgage Solutions.
According to the FDIC, and other government financial organizations, banks should have only accepted reduced income documentation if the loan had other assurances that the borrower could afford the loan. For example, a stated income loan often required a higher down payment than a traditionally underwritten home loan. However, stated income loans rapidly grew in popularity and, as we all remember, underwriting standards slipped. By 2005, stated income loans constituted over one third (37.2%) of all mortgages being originated.
What happened to stated income loans?
Before the housing market collapsed, the Center for Responsible Lending recognized stated income loans as one of the biggest threats to the housing market. Unfortunately, by the time stated income loans were recognized as a threat, they had already damaged the lending marketplace. As real estate prices fell, defaults on these mortgages rose.
Following the collapse of the housing bubble, banks stopped issuing stated income loans. They were simply too risky for banks to issue, and banks couldn’t sell undocumented mortgages in the secondary marketplace.
Can you still find a stated income loan today?
The Dodd-Frank Act of 2010 put the final nail in the coffin for stated income loans. Today, you cannot take out a stated income mortgage.
By law, lenders must fully document a borrower’s ability to repay loans. As a borrower, you must provide documents that prove that you have the income or the assets to repay a loan. These laws apply to all mortgages for owner-occupied housing.
What does this mean for aspiring homeowners? For the self-employed looking to buy a home, lenders typically ask for at least two years of tax returns and a cash flow analysis. Other borrowers may have to submit tax returns, W-2 forms, and their most recent pay stubs to qualify for a mortgage.
Stated income loans may be a product of the past, but alternative loans that share similar qualities to these loans are starting to make a comeback. These loans — more accurately referred to as “alternative documentation loans” or “cash flow loans for investors” — are becoming more popular. These alternative documentation methods meet the ability-to-repay standards in the law, but the methods help borrowers qualify for mortgages that traditional lenders won’t issue.
Lenders offering these alternative income documentation methods are often called “non-QM” lenders. Non-QM stands for non-qualifying mortgage lenders. Non-qualifying doesn’t mean bad or unsuitable mortgages; rather, it means that the loans cannot be sold to Fannie Mae or Freddie Mac.
If you’re a self-employed borrower or a real estate investor, mortgages from a non-QM lender may be the best way to purchase a house. Below we explain how self-employed borrowers and real estate investors can find alternative documentation loans suited to their needs.
How to find bank statement loan programs
Not all lenders issue bank statement loans, but searching the term “bank statement loans” will bring up dozens of loan programs designed for self-employed borrowers.
To get the best deal on a bank statement loan, request a loan estimate from at least three lenders. Loan estimates are documents that includes an estimated interest rate, closing costs, and an estimated monthly payment for a mortgage. According to the Consumer Financial Protection Bureau, the only cost to obtain a loan estimate is a $30 credit report fee, and lenders must give them to you within three business days of receiving your loan application.
Stated income loans for self-employed borrowers
Variable incomes combined with tough documentation requirements make traditional mortgages difficult to obtain for some self-employed borrowers. Today, alternative documentation loans, called bank statement loans, are taking the place of the stated income loans of a decade ago.
Bank statement loans are loans where lenders use bank statements, rather than tax documents, to analyze a borrower’s income. Non-QM lenders working with self-employed borrowers will analyze 12 to 24 months of bank statements to determine a self-employed person’s net income. Each lender uses a slightly different formula to determine a borrower’s net income. In most cases, the net income reflects a person’s income after paying work-related expenses and taxes.
To qualify for a bank statement loan, a borrower typically needs at least two years of experience and income as a self-employed person.
Although the documentation standards differ from traditional lenders, Hutchens told LendingTree “these aren’t liar loans or low-quality loans.”
“We’re documenting everything, and we really know about the borrower’s ability to repay,” he said.
After determining a borrower’s income, lenders determine the maximum loan size based on a ratio of debt to income. The debt-to-income ratio is the percentage of a borrower’s monthly income that could go towards a mortgage and other forms of debt.
Traditional mortgages generally limit debt-to-income ratios to between 36% to 45%, depending on a borrower’s credit score and the size of their down payment. Bank statement lenders may allow borrowers to take on loans with debt-to-income ratios up to 55%, though the actual ratio will depend on the lender and a borrower’s other characteristics.
Bank statement loans allow borrowers to direct a larger portion of their income towards their mortgages, but these loans also require larger down payments. Borrowers with a great credit history may be able to purchase a house with a 10% down payment, but lenders may look for even larger down payments in some cases. By comparison, traditional mortgages allow down payments as low as 3%.
Despite the higher down payment requirements, interest rates on bank statement loans are often 1% to 2% higher than interest rates on traditional mortgages, according to Hutchens. Still, the interest rate gap between traditional and alternative documentation loans has narrowed over the last year. If the trend continues, interest rates on bank statement loans could soon be comparable to interest rates on traditionally underwritten mortgages.
Stated income loans for real estate investors
Another group that stands to benefit from alternative documentation methods are real estate investors. The law that governs income documentation only applies to mortgages for owner-occupied housing. That means that real estate investors may be able to take on mortgages for investment properties without providing any income documentation. Instead, select lenders will underwrite mortgages based on the expected income from the property.
Alternative underwriting standards for investor loans
Even if you’re a real estate investor, traditional lenders use your existing income to qualify you for a loan. Expected rental income is not counted when lenders issue traditional mortgages. Based on these qualification standards, real estate investors may struggle to find a loan.
However, these days not all lenders require investors to document their income. Ability-to-repay laws don’t apply to investors, so some lenders are starting to issue investment loans based on the expected returns of the property. These loans are called cash flow loans since lenders underwrite the loans based on the expected cash flow from the property.
How to find cash flow loans for investors
Cash flow loans are loans that alternative lenders issue on the basis of the expected rental income from a property. “Generally speaking, if the expected rent exceeds the expected debt on a property, the loan will be issued,” Hutchens told LendingTree.
Cash flow mortgages for investors tend to be 30-year mortgages, though they may have adjustable rates.
Expected changes in property values aren’t factored in when lenders issue cash flow loans. Lenders want to be sure that investors can make money on the rents alone, so these loans are best for buy and hold investors.
Lenders who issue these loans create cash flow projections without input from the borrower. They conduct market research to determine the value and stability of the rental market. On top of considering cash flow, lenders will also consider the size of the down payment on a rental property, the personal credit history of the investor and the type of property being purchased.
Investors must put at least 20% to 25% down on a property, but some lenders require even larger down payments. Interest rates on investor loans tend to be higher than rates on traditional mortgages. The lowest rates on investor loans are currently around 6% but can go much higher.
Even if you have a large down payment, finding lenders that issue cash flow loans can be a challenge. Searching the term “cash flow loans for investors” will help borrowers find lenders that work with real estate investors.
It’s important to note that cash flow investment loans may only be available to people who are professional property managers or who have a strong history of rental property ownership.
It’s also important to note that even if you meet the underwriting standards for a loan, the property you’re trying to buy may not. Be sure to speak with multiple lenders to understand their standards before trying to take out a mortgage.
Do stated income loans make sense for you?
Stated income loans may be a financial product of the past, but new innovations in underwriting may help self-employed people and investors take out mortgages.
Products that use “alternative” underwriting standards carry higher interest rates than traditional mortgages, but for the right person, these loans make a lot of sense. Self-employed borrowers can find a uniquely tailored loan that carries the same consumer protections as other loans. Meanwhile, investors can find loans to buy properties that they couldn’t finance based on their income alone.
Whether investors or self-employed, borrowers should be careful to understand their mortgages, and compare rates from multiple lenders before choosing a loan.