by Sean Hess (Sean@StAugTeam.com), Broker and Manager for St. Augustine Team Realty (www.StAugustineTeamRealty.com). Join us on Facebook.
Is the Liar’s Loan back?
Is the liar's loan back?
We’ve been seeing a lot on the internet lately about something called “Stated Income Alt Loans” or “Stated Income Alt-A Loans” being available again. These loans earned the nickname “Liar’s Loans” during the housing bust.
Getting really simplistic here there are 3 types of loans.
A-paper or “prime” loans are loans where everything is documented and verified, and the credit (FICO) score is typically above 680. These loans have the best rates and the best terms.
Alt-A is a loan where you don’t have documentation or where some crucial component is missing. The credit report is typically above 620 and may be as high as 800, but the tax returns might not reflect the income needed for a particular loan. These loans have higher interest rates. More on the Alt-A’s below.
Subprime is a loan where the FICO is typically below 620. High rates, tough terms.
Why Alt-A, the Liar’s Loan?
The Alt-A we saw during the housing boom and bust was called “Stated Income / Stated Asset,” or SISA for short.
These loans were typically for small business owners who had plenty of cash flow, or investors who had a lot of rental income—in other words these borrowers could afford the loan—but due to documentation issues could not qualify for an A-paper or prime loan.
You basically went in and stated your income and your assets, but the bank never verified what you stated (though typically they verified your credit score).
The trouble was during the heat of the housing boom these loans went from a small niche product to something like 30% of all loans written. People were simply going in and stating whatever income was neccessary to get the home they wanted.
I saw this all the time: a buyer would go to a prime lender, not like the loan because it wasn’t big enough for the home they wanted, or couldn’t get a loan because they had way too much debt, and then just go shop for someone who would give them the money. The upshot was that if you were a bricklayer and wanted to live like a large developer, you just stated developer income and “poof!” you got the loan for a mansion.
I’ve read that when the housing market crashed the Liar’s Loans were only 10% of Freddie and Fannie’s portfolio, but accounted for 46% of the defaults.
What I’ve never been able to figure out…and I had a front row seat to the disaster…is why didn’t they verify the borrower’s gross income on these Stated Income Loans? Too much reliance on credit scores?
So is the Liar’s Loan back?
I’ve seen ads on the internet for mortgage brokers who are offering the “Stated Income” loan again, except that this time the borrower has to “prove they can repay the loan.” I haven’t seen the product locally, but I’m sure it’s on its way.
This may actually be a good thing.
It’s still a product that small business owners need.
For example, a small business owner is going to take his or her gross income (cash flow), and then write off the expenses. The income level on the tax return (which will play a major role in getting a loan) will not reflect that the small business owner could have essentially redirected the cash flow towards income to pay for the house.
If the small business owner were to redirect the flow towards income two things could happen: the small business won’t have as much to invest in itself in terms of advertising, equipment, etc., and the small business owner will have a higher income tax payment because he or she will be taking income for themselves instead of spending it on expenses for the business.
Since a lender usually requires two years worth of tax returns to get a prime loan, the small business owner would have to redirect significant cash flow to income for two years before he or she could qualify. And for a small business that would be insane, as there is no benefit to doing that until the business is well established and the owner feels comfortable that the business is well capitalized enough. But by that time his tax return will probably reflect a more comfortable situation, and he could qualify for a prime loan anyway.
The important thing is that these loans are used for who they are intended for.
If the ability to pay is verified, this will be a good thing to have back.
Hire St. Augustine Team Realty when you go to buy or sell. Email us at ReQuestion@StAugTeam.com or call Broker Sean Hess at (904) 386-8327.