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Wednesday, August 22, 2007

Just Say No To Stated Income

by Tanta on 8/22/2007 11:05:00 AM

I'm going to get all detailed and nerdy about this, but it's a huge matter of current policy debate. And, frankly, the cheerleaders for stated-income lending get by with the quickie soundbites that might sound plausible to those who are not well-versed in traditional methods of mortgage underwriting. Those arguments don't hold up to scrutiny, but not enough people are doing that scrutinizing.

My text today is "Should Stated-Income Loans Be Barred?" by Jack Guttentag, who calls himself "The Mortgage Professor." No way that kind of hubris is going unpunished today.

The "Professor" believes that stated income loans, or what he refers to as "SILs," should remain widely available. He offers some examples of "legitimate" SILs:

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; stated-income loans were originally designed to deal with them, but 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.
This, of course, is confusing a lender's rules on calculation of qualifying income with a lender's practice of verifying it. If a lender's guideline is that applicants are qualified at the average of the last two years' income--and sometimes this is a rule--you are using "SIL" to lie your way around the guidelines if, when asked to state your average income for the last two years, you state your income from last month.

Every lender can make an exception to the two-year average rule-of-thumb for determining "qualifying income." If you just stopped being Nurse Sue and became Assistant Professor of Nursing Sue, and you spent the last two years renting while you were building up your credentials for that career move, waiting to buy until it made more financial sense for you, and you can give me the W-2s, rental history, and employment agreement with Nursing U to prove it, I won't just make you a loan, I'll cut your cake and give you a big warm hug because you're my kind of borrower.

If you've been behind the counter at Taco Bell for the last two years, but just recently got put on the payroll at your brother-in-law's new vitamin supplement marketing startup company, and now you'd like to do a cash-out refi to make a little investment with? You will be "qualified" on your average Taco Bell income for the last two years. I'm the underwriter. I make the rules. You do not get to "underwrite yourself" by deciding that my rule on qualifying income is "unfair" to you and therefore you can get around them by "going stated."
If a married couple pool 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.
It appears reasonable to use stated income to lie your way around the lender's rules on credit history? Really?

Since the dawn of time, Prudence has married Spendy. The idea is usually that Prudence is going to "reform" Spendy. The love of a good spouse and all that. Fine. I'm an underwriter, not your mother. You can marry whoever you want to.

The problem is that, since the day after the dawn of time, divorce lawyers have been admitted to the bar, because it does tend to turn out that Prudence and Spendy argue a lot. Sometimes it's over whether they should make the mortgage payment or take the cruise to Aruba. The mortgage payment does not always win.

If you want me to consider you an "economic unit" for the purposes of granting you a loan, then I will do so. But that means that I can consider your creditworthiness in terms of the total unit. If I count Spendy's income, I count Spendy's FICO. Claiming that all the income is Prudence's in order to get around this is fraudulent misrepresentation designed to induce a lender to make a loan that it would not otherwise grant.

Got one of those situations where one spouse has excellent credit and one is just recovering from a past bout of misfortune? Fine. Give me the documents showing the layoff, the illness, the resumption of payments, the well-managed current debt situation, and we'll talk. Tell me it was all a misunderstanding, while refusing to give me paystubs? I don't think so.
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 three months can declare only her current salary with full documentation. Using an SIL, however, the resident can declare her future income.
Look, I love medical residents. My own life has literally been saved by a medical resident. I have never met a finer group of people than medical residents.

A medical school graduate without a job is an unemployed person with decent prospects. I don't lend on prospects. A resident with a residency agreement that will start in September may or may not have any business buying a house right now, but that's OK. I will look at your credit and your debt and your property just like I would anyone else's, and you can get the same deal Nurse Sue got if you qualify.

I have run into very few medical resident loans in which the medical resident wouldn't cough up that residency agreement. I have met one or two 22-year-old Business Administration Majors with the ink still wet on their BS degrees who want me to qualify them for a loan assuming they'll be a Senior Vice President in five years, because that's The Plan.

It doesn't seem to have occurred to The Professor that, at some level, we qualify everybody based on reasonable assumptions about the future. Unless I see something in your file that indicates otherwise, I'll assume you won't get fired tomorrow. I will set my DTI guidelines in such a way that can allow first-time homebuyers, who may be at the beginning, not the peak, of their earning years, to "grow into the loan" a little bit. But I still have to make sure you can carry the loan from payment one. We have just experienced an "Early Payment Default" crisis of unprecedented magnitude, and somebody is telling me I should stop worrying about whether a borrower can make the payment in the here and now. It's like dropping acid without the amusement value.

Does The Professor consider this problem? Why, yes:
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, and if they are available, the price difference between good credit and poor credit is much larger on SILs than on full-doc loans.
This is from the guy who just suggested that borrowers use stated income to get around my FICO rules.

This is after we just had S&P admit that high-FICO SILs are going down just like low-FICO SILs. This is after we just discovered that apparently "the price difference" wasn't nearly enough to cover the losses on this stuff. This is after we discovered that FICOs can be manipulated. This is after we discovered that the RE market doesn't care what your FICO is.

Look. Coming up with all this documentation I'm asking for in these odd situations is time-consuming. This is a mortgage loan. It is the largest debt most people ever contemplate. It has, as we have seen lately, not just profound personal repercussions, but social and political and macro-economic ones, as well. It should be time-consuming, and it should be more expensive, in terms of transaction costs, than getting a $200 Barnes and Noble Master Card at the counter so you can get 10% off your copy of Elvis, Jesus, and Coca-Cola. It does not have to be draconian, just sensible.

Stated income is never sensible. Guidelines that take into account differences in qualifying income or ratios for young people, first-time homebuyers, people with sporadic income, people with lots of cash assets, etc., have always existed and will (if we get through the crunch that stated caused, that is) continue to exist. But those guidelines put the onus on the lender to make an occasionally difficult decision and justify it to the investors, the insurers, the regulators, and the public.

This "stated" thing just pushes the "responsibility" for foolishness back onto the borrower, who cannot pay the cost of his foolishness. That is the situation we are now in. You all can get as morally-disapproving of these borrowers as you like. These borrowers cannot pay the cost of their mistakes. That was the whole problem. It is still the whole problem.

Now we're all paying for it one way or another. And someone calling himself an expert on the mortgage business wants to continue to allow borrowers to underwite their own loans, and lenders to continue to pretend we don't know what this is all about.

The only sane policy is to require verification of any income used in qualifying. That does not mean that Congress writes the rules that define "qualifying" in all cases. Let lenders be "lenders." But let's quit letting borrowers be "lenders except for the fact that it isn't their money."