Monday, March 12, 2007

Mortgages: Liar Loans

You can't open the Business section of a newspaper these days and not read an article about the woeful state of the mortgage industry, notably the subprime sector. A lot of the misery in that sector is tied to "liar's loans": "No Documentation" and "Stated Income" loans that don't require a W-2 or tax return.

Despite having worked in the industry (more accurately, on the IT periphery) for the past 5 years, and having inquired of several people what the logic for those loans is, I have never received a really satisfactory answer. Supposedly it started as something for self-employed. Okay, I understand, if you are self-employed, you haven't got a W2; but you certainly should be able to produce a tax return.

Anyway, from that original purpose, the loans migrated to wage earners (i.e., non-self-employed) and worse, subprime. So any shred of rationale for the program was lost. Oh, I would hear justifications like "it's for people who are willing to pay a premium for the convenience of not having to go through the paperwork". Gimme a break! How much work is it to produce a pay stub and copy of your tax return? If someone is lazy enough to pay 0.25% more on their mortgage to skip that step, they are too lazy to pay their loan!

No, given the classic information asymmetry involved, the vast majority of people taking these loans must be lying. And in fact, the most recent article I read said that, in an audit-style study, 90% of people did exaggerate their income, and 60% of them by more than half!


  1. Yes, it's an unfortunate fact that "no doc" loans have strayed from their original, good intentioned purpose--giving self-employed people who can have variable income from year to year a chance at getting a mortgage.

    In any case, the added premium that the borrower pays is intended to cover the added risk. However, I don't know how secondary mortgage holders account for this added risk (if at all).

  2. I thought the title was just a joke, I don't really know if that mortgage liar loan do exist but after reading all, I realized that the term liar that have been used pertains to a "No Documentation" and "Stated Income" loans.