Stated Income B-paper Angst

There is a fair amount of concern among a certain set of mortgage lenders. Some companies are closing operations or trying to sell them. In essence this is a consequence of some significant changes in the B-paper (poor credit) mortgage industry.

B-paper mortgages had long been profitable. The yields are high and loan officers tend to make more commission. Incentives existed at both ends. But in the past few years a twist occurred. Traditionally, B-paper mortgages had to be fully-documented. The lender wanted to know that despite the borrower's bad credit they did have the ability to make the payments.

The twin forces of greed and stupidity rose up and lenders (and the investors behind them) started to do stated income, B-paper. It worked for a bit but now the late payment and default rates are so high that the lenders are having to create such large loss reserves that they could be approaching insolvency.

So Who's to Blame?

Good question. I would start with the investors who created these products. Between them and the borrowers is a chain consisting (more or less) of the lender, the loan officer and his broker. The fact is that if you are going to create this product it is going to find its way to you.

Look at it from the other end - the borrower. This is the work of a 24 year old relatively naive young man who took courses on how to get rich in real estate and then sort of let his imagination take over. He bought 8 houses in 8 months with no money down.

See: http://iamfacingforeclosure.com/33/will-i-go-to-jail-for-mortgage-fraud/

What I found compelling is the fact that he was so open about what he had done. I would guess that there are a few folks who have done nearly identical things but maybe no one quite so willing to be so public about it.

His take on stated income loans: "I am not a mortgage specialist, but as I understand it, stated income means you state (or make up) how much you make" and "So the lender DOES take an additional risk with these "liar loans" but they balance that risk with higher fees." What is scary is that there could be some truth in his point of view.

What will probably happen will be that the lenders blame the folks who brought them these loans and attempt to get the brokers to buy them back. It is unlikely that that will have any direct effect because the brokers simply do not have the deep pockets that the lenders and investors do.

The deterrent effect of threatening the broker and the loan officer with loss of their license by contending that the loan officer fabricated the income will discourage usually honest participants from doing this but the reality is that if stated income B-paper is going to exist bad loans will find their way to the investor. Some lenders have already weeded the brokers with a high percentage of non-performing loans from their list of folks who can do business with them.

In short, look for an end or at minimum a very large decrease in supply of stated income B-paper.

---

Dick Lepre

Comments

[Matt]

How much of the run-up in real estate values do you think was fueled by investors (or more truthfully, speculators) who had access to money via this type of loan?

[Dick Lepre]

It was just another factor and hardly the core reason why prices ran up. What is distressing is that the increase in B-paper lending did provide some folks the opportunity to become homeowners.

I did not see a lot of speculative buying by B-paper borrowers. From what I saw speculative borrowing in an attempt to flip properties came from folks with good credit. Please understand that this is my own personal experience and should in no way be read as any sort of "big picture" comment.

(the following was added on 2/26)

I do believe that stated income helped, in general, to contribute to the real estate price runup apart from B-paper stated or speculation. Perfectly legitimate buyer/borrowers who will make their payments probably were likely able to qualify for "more loan" than with full documentation and that only served to help run prices up. That was especially applicable when prices were moving up and multiple aggressive (over asking price) offers were made.

[ashok]

Yes, all concerned have role: the borrower, mortgage agent, the broker, the Wall Street hotshot and the investor in the making of a risky mortgage. However, the person who has the ability to say "No" is the investor. It seems incomprehensible that someone, who is already overstretched, would want to borrow more, but human nature being what it is, people will ask. The mortgage agent gets paid on loans made, not on loans paid without a problem. So he or she has no motivation to say "NO" if they can find a willing investor. If the investor says "too risky, not worth the additional premium that borrower pays", then the matter comes to an end and borrower is told to rent for some more time. Unfortunately, we live in a dream world that says “good things never end” and when things get bad, the people burnt turn to the honest and responsible tax payer to bail them out. If someone disagrees, remember the S and L crisis? The investor is not less greedy than the other people in the food chain, but definitely more sophisticated. If they find Wall Street to trying to sell them products they don’t need, then they need to say “NO” to Wall Street. The buck has to stop somewhere and the investor should be the person. If there is no secondary mortgage for very risky mortgages, guess what, there will be no more very risky mortgages