Low documentation or no documentation lending began in the last decade. Essentially, a borrower’s credit score was considered to be the best predictor of default, so why not just accept or reject a mortgage loan application based on a borrower’s FICO (credit) score? These loans were also known as “liar loans.”
These loans were made primarily by specialty lenders, many of which are no longer around. My favorite loan type during the housing bubble years as a NINJA loan (no income, no job).
What happened? The housing market crashed in 2007-2008 and mortgage defaults skyrocketed.
Federal regulations were put in place following the crash that effectively outlawed liar loans. Under so-called ability-to-pay requirements, lenders must take specific steps to ensure homebuyers actually can afford the mortgages. If they don’t, homeowners can sue and potentially win damages that can dwarf the value of the homes.
How can a lender may liar loans and avoid tangling with Federal regulations? But in a throwback to subprime times, Velocity and other specialty lenders routinely offer certain mortgages with limited reviews, if any, of borrowers’ finances. That’s because the rules exempt mortgages made for “business purposes.” The setup lets borrowers avoid typical paperwork, in return for paying higher mortgage rates.
There you have it. Loans where the borrower avoids typical paperwork have higher mortgage rates (what is known as a risk premium).
So the Dodd-Frank and the Consumer Financial Protection Bureau (CFPM), the creators of the Qualified Mortgage (QM) rules with ability to pay rules can be bypassed by declaring the loan as a business loan.
Lenders are also asking for letters of intent. According to Bloomberg, “If they say, ‘you should have known what my intent was,’ we’re going to hold up that document,” Perl said. “It’s a sad state of the world, but we’re looking to make sure we’re not going to be harmed on it.”
At Athas (a lender), the company has discovered less than a handful of instances in the past eight years when buyers moved into homes after saying they wouldn’t, CEO Brian O’Shaughnessy said. But he also suggested that fair-lending rules can make it risky to turn down customers “because I think you’re a liar.”
Tip to lenders: don’t say “Liar” to borrowers.
Dodd-Frank and the CFPB ability to pay and QM rules are actually encouraging renting for households rather than homeownership. Because it is easy to be hard on consumer loans, but less so on business loans.