Earlier this week the Wall Street Journal published a story criticizing the return of stated income loans. Many of the loans that precipitated the 2008 financial crisis were also stated income loans. It was one of those “here we go again” stories.
It tells the story of a 30 year old nursing student who managed to get a $610,000 loan with no tax returns and only 12 months of bank statements and letters from clients. How Outrageous!
How irresponsible for the banks to be taking these types of risks again.
The rest of the story is stated somewhat factually, but not really analyzed in depth. Here are the facts. The lender made the loan at 65% loan to value. That’s a pretty conservative ratio. Even if the borrower defaults, the lender stands a very good chance of getting back 100% of their principal.
Stated income loans are not a problem in and of themselves. In the world of residential underwriting, the fundamental assumption is that the path to repayment of the loan is from someone’s employment income.
If you’re not repaying the loan from your employment income, then there must be something wrong with the borrower.
The problem with the stated income loans back in 2005-2007 is that they were high ratio loans. They were offering loans with very low downpayment, no credit checks, and no verification of income. That’s not the case here. If a homeowner doesn’t have 3 years of income history, it doesn’t mean they’re a bad risk. Bank accounts give a more complete view of spending history than a tax return which provides a snapshot at a single point in time.
I think there’s nothing wrong with stated income loans.
When a lender lends you money, they’re asking only one question. “If I lend you money, how am I going to get it back?” How will I get it back if things go well? How will I get it back if things don’t go well.
The safety of a loan is the combination of security and risk. These variables together define safety.
The security of a loan is based on the lender’s recourse. If the loan ratio is at 90% equity, and 10% loan. I don’t care what the borrowers income is. If I have to foreclose on that property, it will be the best day ever.
On the other hand, if the loan is at 10% equity and 90% loan, my exposure as a lender is much higher.
The risk of the borrower defaulting becomes much more important to the lender in the second scenario.
If I’m a lender at 10% loan to value, I don’t care what the risk of default is. I’m always going to make my money back no matter what the borrower does. There is virtually zero risk as long as I’m secured on title in first lien position. My protection in that instance is the security and the low loan to value ratio.