Less than a decade ago no doc mortgages were the craze that everyone was jumping on top of. While they proved to be a viable alternative for self-employed borrowers, the default rates on these types of mortgages nearly crashed the entire US real estate market.
To recover from the collapse, most lenders have gone from “no doc” to “all doc, all the time.”
As the real estate market has once again found it’s footing, lenders are bringing back alternatives for non-traditional financing that has kept many home buyers on the sidelines.
What Defines a No Doc Loan?
Before the real estate crash of 2008, lenders offered no doc loans to buyers who realistically had no way of repaying the mortgages.
These once popular programs got their name from their lack of documentation requirements as the loans required very few docs to get approved.
The most egregious of these loans was the NINJA loan, with no requirements at all to prove income, job or assets. All the borrowers had to do was state their income, but no one was verifying this information.
Contrary to traditional guidelines, these loans were approved purely on credit history and sometimes assets, but not on employment and income.
How Alternative Income became a “thing”
The no doc loan was originally created to make it easier for business owners to purchase homes. While business owners often have plenty of cash flow, their taxable income, which is used by lenders to qualify for a mortgage, usually came up short.
Standard “no doc” or “stated income” or “no income verification” guidelines required borrowers to have at least six months of their income in reserves. Since this is a form of savings, savings were often used as a substitute for income.
These loans often had fairly high credit score requirements as well. The logic behind this was that if you have the ability to spend money and repay your debts on time, you probably had the income to support it. In this scenario, FICO became another alternative for income.
The problem is that people can borrow money to show sufficient reserves and pay their bills by borrowing even more. This could create the picture of perfect credit and assets without the true means of being able to afford the new mortgage.
The start of the default on No Doc
As the availability of no doc loan options increased, as did their popularity with home buyers. Lenders began pushing the envelope with no doc loans and many removed the safety nets like larger down payments, higher required credit scores and increased asset requirements.
Subprime loans with higher rates, higher fees, no down payment requirements and no income verification quickly took over the market.
As with everything, all good things must come to an end. These “liar loans” were frequently being abused causing far greater default rates than on traditional loans and the lenders started to roll back these options.
This roll back left many without any viable options for new loans in no doc scenarios.
Ability to Repay and QM became a “thing”
To correct the market, the Consumer Finance Protection Bureau (CFPB) introduced new rules for mortgage lenders.
The Bureau amended Regulation Z, which implements the Truth in Lending (TILA), adding the ability-to-repay (ATR) rules.
The new ATR rule simply states that lenders must make a reasonable, good faith determination of a homeowner’s ability to repay their mortgage.
To abide by the new ability-to-repay rule, lenders instituted a “Qualified Mortgage” (QM). These mortgages often include more certain, stable features, making it more likely that the borrower will be able to afford their mortgage.
Non-Prime Lenders Re-Enter the Market
“Subprime” carries a lot of negative connotations after being one of the causing factors behind the recession of 2008.
Non-prime has taken the place of subprime to create programs for borrowers that do not fit into the constraints of the new standards.
Those that still find it difficult to fit into the box of a traditional mortgage program are finding non-prime loans a perfect alternative.
Bank Statement Qualification Standards
Bank Statements are an ideal alternative for the self-employed and independent contractors to prove their income. The programs were designed for those whose tax returns and employment history do not show all the income they’ve truly earned.
At a cursory glance, these mortgage applicants seem to carry more risk than they actually have, because they don’t meet the QM standards.
As opposed to requiring tax returns, W-2’s and paystubs, lenders are basing their approvals on a combination of bank statements and a profit & loss statement for the business.
With Bank Statement programs, the personal deposits from the past 12-24 months are used to calculate income. Some lenders have even gone as far as allowing the use of the businesses bank statements.
Cash Flow Products for Investment Properties
Purchasing investment properties, also known as non-owner occupied properties, provides valuable investment opportunities for the casual homeowner and the seasoned investor alike.
The problem with purchasing these properties is that getting favorable financing terms for investment properties isn’t easy.
What the investor cash flow programs offer is the ability to qualify purely on the cash flow generated by the property, and not the personal income of the borrower. This allows the borrowers to avoid the pitfalls of debt-ratio requirements.
Hard Money Fills the Gap
“Hard money” is a form of financing made by private businesses or individuals for investing in real estate.
Investors often use hard money lenders when purchasing properties in need of work. Properties that are not ready to be immediately occupied make traditional financing next to impossible to obtain.
The key characteristics of Hard Money loans are:
- Beneficial for short term stop-gap measures
- The assumption is always that the property will foreclose and decisions are based on property value
- Often much shorter term with balloon payments due in 6 – 36 months
- Most don’t require any form of income verification.
Non-Prime Mortgage Program Shortcomings
In this post collapse mortgage era we are seeing very stringent lending guidelines and non-prime loans can be a great alternative for those looking to get a no-doc loan.
However, most of these non-prime mortgages come with a set of their very own stringent requirements to qualify.
While lenders exist with lower overall requirements, they typically will want to see a downpayment of at least 20 percent.
Credit score requirements offer a wide range from excellent credit to some that will go as low as a score of 500.
Interest rates for non-prime mortgages are also not what borrowers expect and will generally be several percentage points higher than their prime loan counterparts.
Origination fees and closing costs are also customary with these types of loans.
Over nine million self-employed professionals in the US who have sufficient income fall short of lenders’ income reporting requirements. Fortunately for these homeowners, as well as many others who simply don’t fit the traditional financing mold, great alternatives are starting to once again re-emerge. If you would like to find out more about no doc mortgages, click here to schedule a call with our advisor.