Thursday, December 13, 2007

Is it Ethical for Lenders to Offer Stated Income Mortgages?

In the U.S. some people refer to them as 'liar loans'. They are called 'stated income' mortgages and not everyone knows this, but they are also available, and very popular in Canada. With a stated income mortgage, the applicant is not required to provide proof of the income amount stated on the application. Mortgage lenders consider a number of factors when determining the amount of money they are willing to loan -- one of the factors is the amount of income an applicant earns. Even mainstream lenders such as banks offer these types of loans, where proof of income is not required. Why do such loans exist?

It is understood that people can't always prove the amount of income they earn. For example, self-employed people normally try and minimize the amount of income they report for tax purposes. The amount of income reported by a self-employed person may be reasonable from a tax point of view, but lenders know that the net income may not be a good measure of the person's true earnings.

What are the consequences of lending on a mortgage application where you don't know how much the person actually earns? Potentially, they are very serious. From time to time I meet with people who just want to know the maximum mortgage amount they will qualify for. It is very important for any borrower to carefully consider the size of payment they can afford to carry.

Ultimately, it is the borrower’s responsibility to determine what payment they can afford. It is the lender or mortgage broker's responsibility to make the borrower aware of the types of mortgage products available to them, costs and risks.

With a fixed-rate mortgage the rate and payment are fixed for the term of the mortgage – the most popular terms are between one to five years, though you can get a term as long as twenty-five years. At the end of the term, the renewal rate will be based on then current rates. It usually costs more to get a longer term fixed rate mortgage, but you get peace of mind knowing that your payments will remain fixed for the entire term. Variable rate mortgages are tempting because the rate is usually lower than the current fixed rate; however, if the prime rate goes up, the payment may also go up. If you are considering a variable rate mortgage, you need to know that you will be able to make the payment in the event that the rate goes up.

If the borrower is made aware of their mortgage options and they understand the costs and risks associated with the mortgage they are getting, then in my opinion, it doesn't matter what income amount is stated on the application.