The Lowdown on Low-Doc Loans

By Kenneth R. Harney
Saturday, November 25, 2006

If the IRS wants to spot large numbers of people who are stiffing the tax collectors, it might want to consider auditing a fast-growing segment of the home-mortgage market.

New research suggests that more than 17 percent of all borrowers who take out limited-documentation or no-documentation mortgages do so in part because they have significant under-the-table income they do not report on their federal tax filings.

Limited-documentation and no-documentation mortgages once were used primarily by self-employed professionals, small-business owners and individuals who are heavily dependent upon periodic bonuses or commissions. In limited or no-documentation programs, applicants typically state their income and assets to the loan officer but are not required to show detailed proof of that information for the lender's files.

Generally, applicants are required to have good credit histories, but at the extreme -- no income verification, no asset verification, or NINA -- they need not document much of anything to qualify.

The attraction of such mortgages for lenders or brokers is that they come with higher rates and compensation for the loan originator.

Low-documentation mortgages were only a small fraction of the market in the 1990s, but today they are big business. This year they represent more than 16 percent of all new home loans, according to Inside Mortgage Finance, a Bethesda trade publication. Wall Street rating agency Standard and Poor's says volume jumped by 50 percent from mid-2005 to mid-2006, based on mortgage securities pools it analyzed and rated.

Unlike in earlier periods, however, today's low-doc borrowers are much more likely to be people who could, but choose not to, document their income with W-2 forms or pay stubs. According to a comprehensive survey sponsored by Inside Mortgage Finance and conducted by Campbell Communications, 39 percent of all low-doc borrowers this year are salaried wage-earners, the same percentage as self-employed borrowers.

Why do they prefer to go the low-doc route? Survey designer Geosegment Systems of Nashua, N.H., asked a representative national sample of 2,140 mortgage brokers active in the limited documentation field this question and came up with some eye-opening answers.

While 63 percent of brokers said they knew their self-employed clients had "unreported income" that they wanted to keep off the record, 71 percent said their borrowers' applications were dependent on additional income "from a household member with poor credit."

For example, say a married couple earns $10,000 a month, but one spouse had filed for bankruptcy or lost a house in a previous marriage. Most lenders would want to know about that in order to underwrite the new mortgage and charge an interest rate high enough to cover the added risk. With a low-doc or no-doc loan application, only the spouse with good credit scores would count as the borrower of record.

Forty-five percent of the brokers in the study said a "significant" reason for their clients to avoid full documentation is that they are "self-employed" but have not filed tax returns. Forty-three percent said their clients "can't qualify under standard [debt-to-income] ratios." In other words, if they documented their income and their monthly bills, the new mortgage debt might represent 50 percent or more of their income, a ratio far beyond what most lenders in the regular market consider acceptable.

Twenty-two percent said low-doc clients had "divorce or other legal circumstances" that complicated their financial profiles. About 14 percent said "immigration status" of borrowers was an important issue, while 8 percent said they knew that their low-doc stated-income borrowers actually were unemployed.

Unemployed? To Tom Popik, principal of Geosegment Systems and author of the study, responses such as these suggest "there are significant risk factors" for lenders -- and even for borrowers -- in low-doc and no-doc home loan programs.

Mortgage companies that make or invest in low-doc mortgages largely agree, but they feel that the risks are controlled by the higher rates and fees they charge. After all, if a loan officer knows that the applicants have adequate income and assets to handle a mortgage, that's what's really important -- not the fact that the standard documentation isn't in the file.

When low-doc loans are "carefully underwritten," said Ralph Edwards, head of the division specializing in such loans for mortgage banker Cunningham & Co. of Greensboro, N.C., "they are legitimate solutions to certain borrowers' situations."

But what about stiffing Uncle Sam? Edwards said he doesn't approve of people illegally hiding income, but that the loan officer's or lender's main job is to make certain the mortgage is properly underwritten.

Brokers and lenders "are not paid to do the work of the IRS," he said.

Kenneth R. Harney's e-mail address is

© 2006 The Washington Post Company