Alt-A Loans May Come Back But Could Be More Expensive

Remember stated income loans? In their more responsible guises, they required a substantial down payment of between 20% and 30%, stellar credit scores, reasonable liquid assets (at least six months of the stated income in general, so if you claimed to earn $10,000 a month, you should have had at least $60,000 in a bank somewhere).?? Mortgage interest rates for these things ran only slightly higher than those of traditional loans.

However, the more fanciful versions of stated income loans looked a bit crazy -- some allowed borrowers with awful credit, no down payment, and no assets -- as long as they were willing to pay a screaming high interest rate. And of course, these were the weak links that brought real estate and mortgage markets down all across the country.

But the financial reform legislation passed by the Senate last week could change all that. Contrary to what many folks believe, the new bill does not forbid Alt-A loans. It does require lenders to document borrowers' income but does not specify how. And in the past, there werre plenty of acceptable alternative ways to document income.

One way used by many Alt-A lenders was simply to interpolate the applicant's cash flow by looking at the amount of debt being carried, the applicant's success in carrying that debt, and the applicant's assets, and making an educated guess about his or her probability of paying a mortgage as agreed. For example, someone with $100,000 in available credit, making payments of $3,000 a month and not carrying a balance looks a lot different than a guy who is 60 days late on the $50 payment of a $500 credit line. Ditto if your current house payment is $5,700 a month and you've never been late. It makes sense that you'd be able to handle a new mortgage with a similar payment. Finally, if you have a couple hundred grand in investment accounts, it's probably safe to say that your earnings are pretty hefty.

Another way to verify income is to look at cash flows as evidenced by bank statements. Someone whose business brings in $20,000 a month may have $19,000 a month in write offs. But there may still be a lot of available cash flow. So rather than having available income of $1,000 a month, the borrower shows $15,000 a month in the bank, available for loan payments. Lenders are not the IRS; their responsibility is simply to determine who is most capable of repaying loans. And there is a lot of income out there that doesn't count under standard Fannie Mae and Freddie Mac definitions.

So, experts expect that when lending loosens up as the economy improves, lenders will once again make Alt-A loans, as long as they can abide by the law by finding some way to verify applicants' incomes.

Mortgage Rates May Increase

In the past, those who opted for high grade stated income mortgages paid a very slight premium for the privilege of using alternative documentation methods. That will likely change under the new law. Now, lenders that make these loans will not be allowed to sell them off completely; rather, they will have to maintain reserves in the amount of 5% of the loan balances. This retention will increase the cost of making this kind of loan, which will undoubtedly be passed off to the borrower.?? But that still beats paying cash for your property, or paying taxes on your entire gross income.