A lender's "documentation requirements" stipulate how information about income and assets must be provided by the applicant, and how it will be used by the lender. I am indebted to Catherine Coy, an Upfront Mortgage Broker in the Los Angeles area, for helping me pull this information together.
The most important of the documentation requirements are as follows:
Full documentation: Both income and assets are disclosed and verified, and income is used in determining the applicant's ability to repay the mortgage. Formal verification requires the borrower's employer to verify employment and the borrower's bank to verify deposits. Alternative documentation, designed to save time, accepts copies of the borrower's original bank statements, W-2s and paycheck stubs.
At one time, full documentation was the rule and it remains the standard. In recent years, however, other documentation programs have grown in importance.
Stated income/verified assets: Income is disclosed and the source of the income is verified, but the amount is not verified. Assets are verified, and must meet an adequacy standard such as, for example, 6 months of stated income and 2 months of expected monthly housing expense.
Stated income/stated assets: Both income and assets are disclosed but not verified. However, the source of the borrower's income is verified.
No ratio: Income is disclosed and verified but not used in qualifying the borrower. The standard rule that the borrower's housing expense cannot exceed some specified percent of income, is ignored. Assets are disclosed and verified.
No income: Income is not disclosed, but assets are disclosed and verified, and must meet an adequacy standard.
Stated Assets or No asset verification: Assets are disclosed but not verified, income is disclosed, verified and used to qualify the applicant.
No asset: Assets are not disclosed, but income is disclosed, verified and used to qualify the applicant.
No income/no assets: Neither income nor assets are disclosed.
While these categories are fairly well established in the market, there are numerous differences between individual lenders in the details. For example, under a stated income program lenders may or may not require that applicants sign a form authorizing the lender to request the applicant's tax returns from the IRS in the event the borrower defaults. Similarly, lenders differ in the amount of assets they require.
Why the proliferation of different documentation programs? Lenders have realized that many consumers with the potential for home ownership were shut out of the market by excessively rigid documentation requirements. It also dawned on lenders that documentation could be viewed as a risk factor that could be priced or offset by other risk factors.
Full documentation is the least risky to the lender, no income/no asset is the most risky, and the others are in-between. If the documentation is riskier, lenders will charge more, require risk offsets, or both. The most important risk offsets are large down payments and high credit scores.
This change in lender attitudes toward documentation is similar to the change that occurred in connection with credit rating. At one time, lenders would only deal with what are today classified as "A credit" borrowers. Now, loans are available for "B", "C" and "D"-credit borrowers, but they are priced higher and may require offsets by other risk factors.
The change in attitudes toward both credit rating and documentation requirements has expanded the market. Here are some examples of borrowers who would have not qualified under full documentation requirements:
- Jones is a personal trainer with no fixed place of business who makes good money but can't document it. He can document his mutual funds, and his CPA can verify his self-employed status, so Jones qualifies under a stated income/verified assets plan.
- Smith is in the same business and uses the same CPA as Jones but an uncle is gifting him with the cash he needs. Since Smith cannot document assets, he pays a little more under a stated income/stated asset program.
- King can document income and assets but wants to allocate 58% of his income to housing expenses, which far exceeds conventional guidelines. King qualifies under a no-ratio loan.
- Queen is leaving her job to move to a new city where she has no job, and will buy a house when she gets there with money from the sale of her existing house. She has no income and cannot document assets because her old house won't be sold until after closing on the new one. Nevertheless, she qualifies under a no income/no asset program. If she has a contract of sale on the old house before closing on the new one, she will be able to document assets and can qualify under a no income program.
