Wrongly Stated Income a Problem in Subprime Mortgage Market

Stated income loans cannot be trusted.

So is the conclusion of Comptroller of the Currency John Dugan, who says use of unverified income data in making home mortgage loans to borrowers with poor credit histories should be the exception rather than the rule.

Dugan said the use of a borrower’s stated income, without verification, had helped increase mortgage delinquencies and foreclosures in combination with other lax underwriting standards.

Regulators must decide whether to address the practice as they finalize proposed guidance on bad credit mortgage lending, Dugan said in remarks prepared for a speech to the Neighborhood Housing Services of New York.

“I believe we should, although how we do so and the extent to which we do it are of course decisions that should only be made after careful consideration of the comments we have received,” he said.

Dugan added that generally it is not the job of bank regulators to set underwriting standards, like down payment levels and debt-to-income ratios or interest rate levels. But he said stated income is a “different kind of animal” because it invites misrepresentation and potential fraud.Stated income helped people qualify for bigger loans and more expensive houses, and tempted mortgage brokers to push such practices to gain higher fees.

Dugan cited a Mortgage Asset Research Institute study that found 90 percent of home purchase loan borrowers reported incomes higher than those found on file with the Internal Revenue Service and almost 60 percent of the stated incomes were exaggerated by more than 50 percent.

Another survey of more than 2,100 mortgage brokers, reported by Inside Mortgage Finance, found that 43 percent of mortgage brokers who use low or no-documentation loan products know their borrowers cannot qualify under standard debt-to-income ratios.

“Let’s not sugar-coat what’s going on here,” said Dugan whose agency regulates national banks that originated 10 percent of all subprime mortgages in 2006. “The practice of inflating income is at best misleading, and at worst, fraudulent.”

In a lofty market, borrowers used rising home prices to service their debts by mortgage refinancing and using the equity generated by house price appreciation, he said. Refinancing also brought in another round of fees for brokers and lenders.

“The rapidly rising housing market of 2003-2005 was the perfect petri dish to incubate the widespread practice of stated income loans,” Dugan said.

However, delinquent payments and foreclosures have since risen as many adjustable rate home loans reset at higher interest rates and U.S. home prices stagnate or fall in some areas.

Dugan said he found it telling that lenders have responded to new housing market conditions by tightening standards on stated income and that loan servicers are verifying income before a loan is restructured.