Behind the meltdown: No-proof loans fed mortgage bubble

Bloated income claims hit the vulnerable

By Dale Kasler, Phillip Reese and Jim Wasserman - dkasler@sacbee.com

Last Updated 8:17 pm PST Wednesday, November 28, 2007
Story appeared in MAIN NEWS section, Page A1

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Leonard finds the mere existence of no-doc loans astounding. "I find it quite striking that you have to produce a pay stub to get a 'payday loan,' but you can get a $500,000 mortgage without even that," he said.

The California Association of Mortgage Brokers defends the industry's conduct and says borrowers took the lead on pumping up their reported incomes.

"I have turned down many clients who have told me they make 'this' amount of money," said Jon Kaempfer of Vitek Mortgage Group in Sacramento, a member of the association's board. "Well, I don't believe them and I turn them down – I don't believe you're making $12,000 a month raking leaves."

No-doc loans figure in a major fraud case in the area. In September, a federal grand jury accused four men, including a mortgage broker, of luring investors into buying $8 million worth of homes in Elk Grove by telling them they could resell them to "prequalified" purchasers waiting in the wings. Prosecutors said the prequalified buyers didn't exist.

To keep the plan going, the four men pumped up investors' incomes on loan applications, the grand jury said. The four have pleaded not guilty.

"It was always a 'hurry up' thing," one investor, self-employed Elk Grove landscaper Tim McDaniel, said in an interview. "'Don't worry about it, don't worry about it, just go sign the papers.'"

McDaniel, who said he learned later that his income was tripled on the loan applications, lost two houses to foreclosure, is in default on a third and is suing the men.

Legitimate use distorted

Industry officials said no-doc loans have a legitimate purpose: to help self-employed entrepreneurs and others who have the means to buy a home but can't easily prove their incomes.

They've led to problems before. A slew of no-doc loans in the late 1980s led to major losses for several aggressive lenders, said Keith Gumbinger, vice president of HSH Associates mortgage research firm in New Jersey.

Things are worse this time, he said. In the 1980s, no-doc loans at least required substantial down payments. In the latest boom, borrowers could obtain no-doc loans with zero down payments, "teaser rates" and other come-ons, Gumbinger said.

"The layering of those individual risks, one on top of the other, has created a complicated mess," he said.

No-docs were used more aggressively as the boom began to fizzle.

In 2005, while the market was still relatively healthy, the median household income of Sacramento County homebuyers was $78,650, according to U.S. census data. The median income reported on loan applications was $90,000, a difference of 14 percent, according to records available under the Federal Home Mortgage Disclosure Act.

In 2006, as the market went cold, incomes were pumped up even more. Homebuyers in Sacramento County earned median household income of $79,735, but the median income reported on mortgage applications was $97,000, a 22 percent difference.

"You had to expand the buyer pool (as the market slowed), and the only way to expand the buyer pools, considering the high home prices, was to inflate the incomes," said Thompson, a critic of the practice.

Some in Congress want to outlaw it. A bill introduced last spring by Sen. Charles Schumer, D-N.Y., would force lenders to examine tax returns, payroll receipts and other records before approving a borrower.

Income gap stretches wide

Income discrepancies pop up throughout the region. The median income on mortgage applications in Yolo County last year was $104,000; the median income of Yolo homebuyers was $83,400. El Dorado County homebuyers earned $100,000 but their loan applications said they earned $126,000. Placer County homebuyers earned $90,115, but loan applications said they earned $116,000.

The disconnect between stated and actual incomes appears to be greatest in lower-income areas. Census figures for the medium incomes of homebuyers were unavailable for individual neighborhoods, but figures for medium household incomes strongly suggest similar gaps.

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About the writer:

Call The Bee's Dale Kasler, (916) 321-1066.

Rose Marie Reyes packs her belongings at the Natomas house that she is losing after getting a no-documentation refinance loan with ruinous payments. Bryan Patrick / bpatrick@sacbee.com

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MULTIMEDIA

Interactive graphic: Subprime loans by community
A TIMELINE: HOW LOAN STANDARDS HAVE CHANGED

2000-2002
Seven years ago, the traditional patterns of mortgage lending dominated. Nearly 80 percent of mortgages in Amador, El Dorado, Nevada, Placer, Sacramento, Sutter, Yolo and Yuba counties were fixed-rate loans where the monthly payment stayed the same for 15, 20 or 30 years. Lenders asked for pay stubs or W2 forms to verify incomes.

2003-2004
The lowest mortgage interest rates in years triggered a home-buying binge in Sacramento, driving up prices. The combination of low interest rates and higher prices started a stampede into riskier adjustable rate mortgages that came with lower initial monthly payments. In 2003, nearly one-third of area homebuyers and people refinancing their homes used adjustable-rate loans. In 2004, two-thirds used them.

As prices rose in 2004, subprime lending – higher-cost loans to people with troubled credit histories – reached its peak. In 2004, 28 percent of borrowers in El Dorado, Placer, Sacramento and Yolo counties received riskier subprime loans. Subprime totaled 36 percent of 2004 loans in Sutter and Yuba counties.

2005-2006
As prices rose, 73 percent of capital-area borrowers turned in 2005 to adjustable-rate loans, many with low "teaser" rates that would reset in two or three years. Lenders told many not to worry – they could refinance before then.

As global investors pushed capital into the U.S. home market and broker fees soared for the riskiest loans, standards relaxed significantly. More lenders turned to "stated income" loans that didn't verify borrowers' financial situations and often required no down payments. In 2005, 35.5 percent of California's first-time homebuyers made no down payments; the next year it jumped to 41 percent. In late 2005 home prices peaked, then fell throughout 2006. Many new borrowers found they couldn't refinance because they owed more than their houses were worth. Defaults mounted, starting a run of foreclosures.

2007
A dramatic rise in defaults by subprime buyers caused several big lenders to implode. Global investors stopped supplying capital for new loans, bringing a massive credit crunch. Almost overnight, mortgage experts say, an estimated 30 percent of the Sacramento region's buyer market dried up as new tighter mortgage lending standards blocked would-be borrowers. Stated-income loans almost disappeared, interest-only loans became rare and subprime lending ground almost to a halt. Lenders say they're largely back to old-fashioned lending, emphasizing fixed-rate loans, down payments and verified incomes.

Sources: First American Loan Performance, DataQuick Information Systems, California Association of Realtors, 1st National Home Loans, Roseville, Platinum Home Mortgage

GLOSSARY OF TERMS

Adjustable-rate mortgage: The monthly payment and interest rate is fixed for a temporary period – commonly two, three, five, seven or 10 years. That typically allows a lower monthly payment than with a fixed-rate loan. After the temporary period the interest rate "resets," typically making the monthly payment more expensive.

Option ARM: Considered one of the riskiest mortgages, it provides the borrower up to four monthly payment options. Typically, the lowest payment options don't cover the cost of interest; the unpaid amount is added to the loan balance. At about three years that larger loan amount "recasts" into a regular loan with significantly higher monthly payments. Many borrowers are unable to afford the new payments.

Stated income loan: Borrower provides no documentation of income such as pay stubs or tax returns. Lender makes a loan based on borrower's credit score and other assets.

Foreclosure: When a bank or lender repossesses the home. It's also called a trustee's deed.

Notices of default: When a borrower misses two or three monthly mortgage payments, lenders file a formal notice of default with the county recorder's office. It's the first step in the process that leads to foreclosure.

REO property: Short for "real estate owned." It means a bank now owns the home after taking it back from an owner who hasn't made payments.

Short sale: A distress sale in which the lender accepts less than what's owed on the house to avoid the more expensive process of foreclosing and reselling in a declining market.

Subprime loans: Higher-cost loans made to people with blemished credit histories. Interest rates for these loans are often three percentage points higher than regular loans. Lenders attribute the higher rates to the greater risks they take on when making the loan.

Source: Bee research