The Dangers of Stated Income Loans

Stated income loans can help a self-employed borrower qualify for a mortgage without documenting their income. But, dangers abound with these loans because they are ripe for misuse. Also, the loans are more expensive, less flexible on equity requirements, and can be hard to find. The following information explains what stated income loans are and what dangers to look out for.

What Is a Stated Income Loan? 

When considering you for a mortgage, a lender looks at your credit score, your income-to-debt ratio and your down payment. Your credit score is easily verifiable by the lender through the three main credit bureaus. Your down payment is clear because you have to put that money down. Your income is subject to verification, typically through IRS issued W-2s. A lender will review the past two years and establish a gross monthly income amount.

In stated income loans, you don't provide W-2s or tax returns; instead, you state your income and authorize the lender to check your tax returns. For the self-employed person, this opens access to mortgage borrowing because they have no other way to document their income. 

The dangers are that stated income can be falsified and someone can state they earn more than they do. Then, a lender would offer them a home loan they can not truly afford.  Although this program was useful for self-employed persons, its abuse has lenders applying restrictive guidelines, such as large dcwnpayment amounts or high rates, to discontinue their use.

Higher Interest Rates

The interest rate you pay on a loan is a reflection of your risk. So, if your credit score is low, your interest rate will be higher. Similarly, with stated income loans, your income is subject to verification but typically unverified at loan closing. This increases the lender's risk because you could be lying about your income. That increased risk results in a higher interest rate.

Lenders increase rates on these loan products anywhere from .50 to 2.00 percent higher, when compared to verified income loans.  For example, if market rates are 7 percent, a stated loan rate can be 9 percent.  The marked difference will affect monthly payments drastically, making the home the borrower purchases all that much less affordable.  

Less Down Payment Flexibility

For most borrowers, a down payment can range from 0 to 20 percent. You have flexibility to put less than 20 percent down and pay PMI, or private mortgage insurance.  However, stated income loans require 20 to 30 percent down. Therefore, your assets and reserves are invested in the property purchased.  If a self-employed borrower purchased a home, with a high rate and a high monthly payment, they also used up most of their funds, which further exacerbates their problem with making their payments.

Ripe for Misuse

Experienced mortgage brokers say borrowers with stated income loans tend to exaggerate on their mortgage applications because the opportunity is there. However, if you stretch your income to get a loan, you are still responsible to pay it back. Falsifying information is not recommended. Not only will you not be able to afford the home, but your rate will be higher, and you will have very little in reserves in the case of an emergency.  All businesses have cyclical profits, so, if your business should hit a down cycle, you will need to be sure you can make the payment and avoid overextending yourself.

The rule of thumb is that your house payment should be 28 percent of your monthly gross income. A danger of stated income loans is the ability to get that ratio out of the norm and face a monthly payment you can't afford.

Harder to Find

In a rising housing market, when lenders are competing for borrowers as interest rates go up, unconventional financing options such as a stated income loan are plentiful. But if you are self-employed in a declining housing market, where defaults are rising and lenders grow more cautious, it can be difficult to find a stated income lender.