August 6, 2007
A stated income loan (SIL) qualifies a borrower using the income the
borrower states, as opposed to the income the borrower can document.
With an SIL, the lender agrees not to verify the income the borrower
states on the application.
As one might expect, SILs are priced higher than fully documented loans,
and the foreclosure rate is also higher. With overall foreclosure rates
reaching uncomfortably high levels, SILs have emerged as a possible weak
point in the underwriting process. Regulators and legislators have been
considering whether they should bar SILs, or limit them in some way.
Why Single Out Stated Income Loans?
Singling out SILs for special regulatory treatment is a little strange
on the face of it, since they are only one of a spectrum of alternative
forms of documentation that have developed in the marketplace. Ranked by
restrictiveness, furthermore, SILs stand immediately below full
documentation, and above all the others.
While lenders don’t verify income on an SIL, they do verify assets and
employment. On a "No Ratio" loan, income is not reported at all; on a
"Stated Income/Stated Assets" loan, both income and assets are stated;
on a "No Income/No Assets" loan, neither income not assets are reported;
and on a "No Doc" loan, nothing is reported including employment.
These alternative forms of documentation are priced higher than SILs and
have higher foreclosure rates, but have not attracted the same
attention. No doubt, the reason is that SILs are the most common type of
alternative documentation, and may account for as many loans as all the
others put together.
The Borrowers Protection Act of 2007, introduced in the Senate by
Senator Schumer of NY, declares that "A statement provided by the
borrower of the income…of the borrower, without other documentation…is
not sufficient verification for…assessing the ability of the consumer to
pay." This would leave lenders free to employ less restrictive forms of
documentation, including no documentation requirements at all.
Restricting Stated Income Loans Would Be Costly
The SIL was itself a response to limitations of the underwriting system.
Many prospective home buyers have the income to afford a mortgage, but
can’t meet the standards of full documentation.
Full documentation generally requires that applicants show that the
income they claim was actually earned in each of the two prior years.
This is usually done by presenting W-2s or tax returns for two years.
Self-employed borrowers usually have the most trouble meeting this
requirement, and stated income loans were originally designed to deal
with them. A loan originator recalled that "we required two years worth
of tax returns and a year-to-date profit and loss statement. These were
often bulky and required almost a CPA designation to calculate all the
income the client earned… The stated income loan...cut down the work
required and the size of the loan file tremendously."
Other legitimate cases quickly emerged. Many applicants with incomes
from salaries can’t meet full-doc requirements. They may not have held
their position long enough, or their latest increase in salary may not
be reflected in documents covering past income.
Other uses are more questionable. If a married couple pools their
incomes and one has a much lower credit score than the other, the full
doc rule is that the lower score is the one used. Stated income allows
the partner with the higher score to claim all the income, which appears
reasonable in most situations, especially in community property states
where husband and wife share legal right to each other’s incomes.
If an underwriter was asked whether or not this was a legitimate use of
stated income documentation, the answer would be "no". But mortgage
brokers often feel justified in advising borrowers to do it because the
income is available to the borrower "and that’s what counts".
Full documentation rules are backward-looking; forecasts of future
changes in income are not accepted, no matter how well grounded they may
be. This means, for example, that the low-paid medical resident who,
barring a catastrophe, will triple her salary in 3 months can declare
only her current salary with full documentation. Using a SIL, however,
the resident can declare her future income. This is also stretching the
rules, but it works because the income materializes in all but a small
number of cases.
The Valid Rap on Stated Income Loans
The valid rap on SILs is that some borrowers, without any realistic
basis for expecting a rise in income, lie about their current income and
take loans they cannot afford. This irrational behavior of some
borrowers may be encouraged by rational behavior on the part of
rapacious loan officers or brokers, who get paid only if a loan closes
and have no interest in what happens afterwards.
Because borrowers with high credit scores are much less likely to be
irrational in their financial affairs, lenders place a lot more weight
on credit scores of SIL borrowers than of full doc borrowers. SILs will
not be available to borrowers with very low credit scores. If they are
available, the price difference between good credit and poor credit is
much larger on SILs than on full-doc loans (see the table below).
The Federal Financial Regulatory Agencies looked at SILs in their
analysis of problems in the sub-prime market, and concluded that they
"should be accepted only if there are mitigating factors that clearly
minimize the need for verification of repayment capacity". Since the
rules governing SIL are part of the mosaic of underwriting rules in
which everything depends on everything else, there are always mitigating
factors. In effect, the agencies elected to go through the motions but
not to do any harm. Hopefully, our legislators will elect to do the
same.
Par Rate on 30-Year FRM for $320,000 on a $400,000 Single-family Home
Purchase in California, July 20, 2007
| |
Full Documentation |
Income |
| |
FICO 720 |
FICO 620 |
FICO 720 |
FICO 620 |
| Purchase Primary Residence |
6.75% |
6.75% |
7.00% |
8.375% |
| Cash-Out Refi, Primary Residence |
6.875% |
6.875% |
7.25% |
8.875% |
| Cash-Out Refi, Investment Property |
7.375% |
7.375% |
9.375% |
10.375% |
Source: Amerisave